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The Microstructure of the Bond Market in the 20th Century

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Bruno Biais
Richard C. Green

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Abstract

Bonds are traded in OTC markets, where opacity and fragmentation imply large transaction costs for retail investors. Is there something special about bonds, in contrast to stocks, that precludes trading in transparent, limit-order markets? Historical experience suggests this is not the case. Before WWII, there was an active market in corporate and municipal bonds on the NYSE. Activity dropped dramatically, in the late 1920s for municipals and in the mid 1940s for corporate, as trading migrated to the OTC market. This migration occurred simultaneously with an increase in the role of institutional investors, which fare better than retail investors in OTC market. Based on current and historical high frequency data, we find that, for retail investors, trading costs in municipal bonds were half as large in 1926-1927 as they are now. The difference in transactions costs is likely to reflect the difference in market structures.

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Paper provided by Carnegie Mellon University, Tepper School of Business in its series GSIA Working Papers with number 2005-E57.

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Handle: RePEc:cmu:gsiawp:2073810639

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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Rajan, Raghuram G. & Zingales, Luigi, 2003. "The great reversals: the politics of financial development in the twentieth century," Journal of Financial Economics, Elsevier, vol. 69(1), pages 5-50, July. [Downloadable!] (restricted)
  2. Rajan, Raghuram G & Zingales, Luigi, 1995. " What Do We Know about Capital Structure? Some Evidence from International Data," Journal of Finance, American Finance Association, vol. 50(5), pages 1421-60, December. [Downloadable!] (restricted)
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  3. Bessembinder, Hendrik & Maxwell, William & Venkataraman, Kumar, 2006. "Market transparency, liquidity externalities, and institutional trading costs in corporate bonds," Journal of Financial Economics, Elsevier, vol. 82(2), pages 251-288, November. [Downloadable!] (restricted)
  4. Lawrence E. Harris & Michael S. Piwowar, 2006. "Secondary Trading Costs in the Municipal Bond Market," Journal of Finance, American Finance Association, vol. 61(3), pages 1361-1397, 06. [Downloadable!] (restricted)
  5. Richard C. Green & Burton Hollifield & Norman Schürhoff, 2005. "Financial Intermediation and the Costs of Trading in an Opaque Market," FAME Research Paper Series rp130, International Center for Financial Asset Management and Engineering. [Downloadable!]
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  6. Robert M. Dammon & Chester S. Spatt & Harold H. Zhang, 2004. "Optimal Asset Location and Allocation with Taxable and Tax-Deferred Investing," Journal of Finance, American Finance Association, vol. 59(3), pages 999-1037, 06. [Downloadable!] (restricted)
  7. Dan Bernhardt & Vladimir Dvoracek & Eric Hughson & Ingrid M. Werner, 2005. "Why Do Larger Orders Receive Discounts on the London Stock Exchange?," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 18(4), pages 1343-1368. [Downloadable!] (restricted)
  8. Anat R. Admati, Paul Pfleiderer, 1988. "A Theory of Intraday Patterns: Volume and Price Variability," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 1(1), pages 3-40. [Downloadable!] (restricted)
  9. Pagano, Marco, 1989. "Trading Volume and Asset Liquidity," The Quarterly Journal of Economics, MIT Press, vol. 104(2), pages 255-74, May. [Downloadable!] (restricted)
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  10. Green, Richard C. & Hollifield, Burton & Schurhoff, Norman, 2007. "Dealer intermediation and price behavior in the aftermarket for new bond issues," Journal of Financial Economics, Elsevier, vol. 86(3), pages 643-682, December. [Downloadable!] (restricted)
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  11. Biais, Bruno & Glosten, Larry & Spatt, Chester, 2005. "Market microstructure: A survey of microfoundations, empirical results, and policy implications," Journal of Financial Markets, Elsevier, vol. 8(2), pages 217-264, May. [Downloadable!] (restricted)
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  1. Andrew Ang & Vineer Bhansali & Yuhang Xing, 2008. "Taxes on Tax-Exempt Bonds," NBER Working Papers 14496, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  2. Ricardo Lagos & Guillaume Rocheteau, 2007. "Liquidity in asset markets with search frictions," Working Paper 0706, Federal Reserve Bank of Cleveland. [Downloadable!]
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