Bloomberg and TradeWeb cover prices

September 23, 2009

I got an email query on cover prices for RFQs after my last post, so I went back to some old analysis of RFQs I did in 2006 to check. My code was getting the cover price from ION MarketView’s trading chain for the RFQs that traded with us on Bloomberg and TradeWeb. If the client traded away, with another dealer, or rejected, we would see a cover price of zero. This asymmetry allows a dealer to calculate excess winning margins for RFQs won, but not to see how far off the best price the dealer is for RFQs that trade away.

The excess winning margin is the difference between a winning price and the cover price. If the gap is too great, then maybe the dealer is suffering from a form of the winners curse. The obvious response is to make pricing less aggressive. But the fact that losing dealers in an RFQ don’t see the winning price deters that. In the face of that asymmetry the right solution is probably to have real time feedback between hit ratios and pricing aggression…

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3 Responses to “Bloomberg and TradeWeb cover prices”

  1. John Greenan Says:

    There’s another way to view this. Look at Tradeweb or Bloomberg. From memory a buy-side can ask for 5 quotes.
    Let’s make a couple of assumptions:
    1. All five firms quote.
    2. The best quote may or may not be traded by the buy-side.
    3. The banks that do not make the trade receive a big fat zero of information – they do not know if the trade was done elsewhere or if the trade was not done at all.
    4. The bank that does make the trade knows they have traded and finds out the next best quote in that direction.
    5. Banks cannot talk to each other about a specific trade to find out if they traded or not
    6. Quotes are always in the full size of the RFQ – no partial quotes.
    7. Quotes are always for a specific size and side. Two way quotes are not used.
    8. Trades in the market place are not one way – buy-sides will be buyers and sellers of a specific bond within a short time frame (not saying that the same firm will buy and sell, merely that buy side A may be buying bond X at the same time as buy-side B is selling bond X).

    So – what COULD the bank that trades do? It could say “let’s tighten up pricing on this instrument – make our price closer to the next best, so we still trade, but at a better price from the banks perspective”. Now, it will not know if the next firm is axed so has a skewed spread or whether the next firm has a wider spread – since there is only a one sided quote. Unless the same bank also traded the same bond in the other side at a similar time.

    Ok, but what action can the other four banks take? Well, they don’t know if it was a ‘quote and miss’ OR a non-trade, so they can either leave things as they are OR improve their price (it would not make sense to make your price worse if you did not get the trade – if you want to trade). One would assume that the four banks would not go bonkers in improving prices – that the process of price improvement would be slow and iterative, rather than a big jump.

    So – in this scenario – we see prices offered by the five banks either staying the same OR possibly moving to a tighter dispersion. This does not sound like a bad outcome.

    Take the alternative – that the four non trading banks see the exact details of the five quotes. They also know which one traded if at all. And if there is a trade in the same bond in a similar size at a similar time they now know the details of the pricing model output from the other banks.

    So – what would you do it you were one of the four banks? Well, you can work out exactly what everyone else is doing and you can then start to game this.

    Now – I’d suggest that the four banks would end up looking at a game to gradually worsen prices to the buy-side.

    In short – I think you have to look at a game theoretical approach for price discovery for what is effectively a complex oligopsony. You may argue that since there are relatively few independent actors in this it’s possibly a bi-lateral oligopsony/oligopoly.

    Takes off economists hat and places damp flannel on forehead…

  2. etrading Says:

    Assumption 3 doesn’t hold, nor the alternative you describe later. The dealers that don’t get the trade do know whether it was done away, or if the client rejected all the quotes. If done away they know if they were cover or cover tied or not…

    I guess that just complicates the game theoretic reasoning you outline !

  3. John Greenan Says:

    Question – if a bank is joint next best price, do they know how many other banks quoted the same price as they did? That’s quite important. Knowing that one other bank quoted the same is not as important as knowing that three or four other banks quoted the same.

    So – 3 should read
    3a. The banks that do not make the trade find out if the trade was done or not.
    3b. The one or more banks that do not make the trade that were next best or joint next best price do find out that they were next best or joint next best.

    OK, when I get some time I’ll figure it out. I don’t think that the end result is too sensitive to that change. I still think that a game theoretic approach is the right one but made more complicated by the incorrect assumptions.

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