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Size And Heterogeneity Matter. A Microstructure-Based Analysis Of Regulation Of Secondary Markets For Government Bonds

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  • J.Ramon Martinez-Resano

    (Bank of Spain)

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    Abstract

    This paper deals with the economics of secondary markets for government bonds. Ultimately, the analysis is shaped by a public policy goal: assessing the elements of a regulatory framework for these markets. In that regard, the decisive role of market structure leads to a critical review of microstructure conclusions relevant specifically for government debt markets. It is argued that the nature of information asymmetries and matching costs in government debt markets determines a bias towards a fragmented microstructure at odds both with exchange-like arrangements and with ordinary regulatory approaches. Hence, a generic conclusion highlights the risks of blindly transposing regulatory principles from the equity markets area without due regard to the specifics of the bond market. As a specific application of this idea, the paper critically reviews electronic trading platforms that emulate exchange-like order execution solutions. More specifically, the paper opposes the hybrid microstructure (pure limit order book plus affirmative quoting obligation) faced by European primary dealers and the arbitrage-based approach to market-making found in US inter-dealer markets. The Citigroup disruptive trade in August 2004 is analyzed from this perspective. Government bond regulation is argued to necessarily depart from ordinary approaches also because it captures the diverse interests of various governmental agencies. As an application of this principle, the paper discusses repo and short-selling regulation in government bond markets. The atypical market structure and the multi- agency endeavour around government bond markets raise the chances of regulatory failures. Nevertheless, it is argued that a reliance on competition, integrative infrastructure and basic systemic protections as over-arching principles for regulation is consistent with recommendations from relevant economic theory. Finally, political economy issues arising in implementation of transparency, disclosure or retail investor protection will be addressed in the context of selected country cases.

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    File URL: http://128.118.178.162/eps/fin/papers/0508/0508007.pdf
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    Bibliographic Info

    Paper provided by EconWPA in its series Finance with number 0508007.

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    Length: 63 pages
    Date of creation: 05 Aug 2005
    Date of revision:
    Handle: RePEc:wpa:wuwpfi:0508007

    Note: Type of Document - pdf; pages: 63
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    Web page: http://128.118.178.162

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    Keywords: government bonds; microstructure; regulation;

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    Cited by:
    1. Dunne, Peter & Moore, Michael J. & Portes, Richard, 2006. "An Empirical Analysis of Transparency-Related Characteristics of European and US Sovereign Bond Markets," Research Technical Papers 9/RT/06, Central Bank of Ireland.

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