TRACE the blocks

September 26, 2006

Accrued Interest posts on a study claiming that the TRACE corporate bond trade reporting systems had collapsed spreads to the tune of $1 billion. There are many other factors that could affect spreads beyond TRACE, so I question the attribution of all of that billion to the reporting effect. Accrued points to increased competition – a very plausible explanation as the study period coincides with the rise of electronic trading for bonds, which has surely driven down spreads.

Reporting could cause spreads to widen for block trades – especially for the less liquid securities. If an institutional trader wants to sell a block of an illiquid corporate bond, then any dealer offering liquidity will have to price in the cost of front runners taking the trades he’ll need to make to unwind his inventory when they see the block reported. Any front running trader who’s long will see the block reported, sell his long position, and buy it back cheaper when the dealer drives prices down selling off  his block.

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