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Price Discovery in Illiquid Markets: Do Financial Asset Prices Rise Faster Than They Fall?

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  • RICHARD C. GREEN
  • DAN LI
  • NORMAN SCHÜRHOFF

Abstract

We study price discovery in municipal bonds, an important OTC market. As in markets for consumer goods, prices “rise faster than they fall.” Round‐trip profits to dealers on retail trades increase in rising markets but do not decrease in falling markets. Further, effective half‐spreads increase or decrease more when movements in fundamentals favor dealers. Yield spreads relative to Treasuries also adjust with asymmetric speed in rising and falling markets. Finally, intraday price dispersion is asymmetric in rising and falling markets, as consumer search theory would predict.

Suggested Citation

  • Richard C. Green & Dan Li & Norman Schürhoff, 2010. "Price Discovery in Illiquid Markets: Do Financial Asset Prices Rise Faster Than They Fall?," Journal of Finance, American Finance Association, vol. 65(5), pages 1669-1702, October.
  • Handle: RePEc:bla:jfinan:v:65:y:2010:i:5:p:1669-1702
    DOI: 10.1111/j.1540-6261.2010.01590.x
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    File URL: https://doi.org/10.1111/j.1540-6261.2010.01590.x
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    Citations

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    Cited by:

    1. Hendershott, Terrence & Li, Dan & Livdan, Dmitry & Sch�rhoff, Norman, 2017. "Relationship Trading in OTC Markets," CEPR Discussion Papers 12472, C.E.P.R. Discussion Papers.
    2. Marsch, I. & Wagner, W.B., 2012. "Why is Price Discovery in Credit Default Swap Markets News-Specific?," Discussion Paper 2012-006, Tilburg University, Center for Economic Research.
    3. Antoniou, Fabio & Fiocco, Raffaele & Guo, Dongyu, 2017. "Asymmetric price adjustments: A supply side approach," Working Papers 2072/306511, Universitat Rovira i Virgili, Department of Economics.
    4. Hau, Harald & Hoffmann, Peter & Langfield, Sam & Timmer, Yannick, 2017. "Discriminatory pricing of over-the-counter derivatives," ESRB Working Paper Series 61, European Systemic Risk Board.
    5. Cenedese, Gino & Ranaldo, Angelo & Vasios, Michalis, 2020. "OTC premia," Journal of Financial Economics, Elsevier, vol. 136(1), pages 86-105.
    6. Dan Li & Norman Schürhoff, 2019. "Dealer Networks," Journal of Finance, American Finance Association, vol. 74(1), pages 91-144, February.
    7. Cestau, Dario & Hollifield, Burton & Li, Dan & Schürhoff, Norman, 2018. "Municipal Bond Markets," CEPR Discussion Papers 13301, C.E.P.R. Discussion Papers.
    8. Hörner, Johannes & Lovo, Stefano & Tomala, Tristan, 2018. "Belief-free price formation," Journal of Financial Economics, Elsevier, vol. 127(2), pages 342-365.
    9. Wang, Junbo & Wu, Chunchi, 2015. "Liquidity, credit quality, and the relation between volatility and trading activity: Evidence from the corporate bond market," Journal of Banking & Finance, Elsevier, vol. 50(C), pages 183-203.
    10. Marsch, I. & Wagner, W.B., 2012. "Why is Price Discovery in Credit Default Swap Markets News-Specific?," Other publications TiSEM 2085f4c9-2035-489f-ae63-4, Tilburg University, School of Economics and Management.
    11. Kurmann, André & Rabinovich, Stanislav, 2018. "Dynamic inefficiency in decentralized capital markets," Journal of Economic Theory, Elsevier, vol. 173(C), pages 231-256.
    12. Mun, Kyung-Chun, 2012. "The joint response of stock and foreign exchange markets to macroeconomic surprises: Using US and Japanese data," Journal of Banking & Finance, Elsevier, vol. 36(2), pages 383-394.
    13. Marco Di Maggio & Amir Kermani & Zhaogang Song, 2016. "The Value of Trading Relationships in Turbulent Times," NBER Working Papers 22332, National Bureau of Economic Research, Inc.
    14. Cuny, Christine, 2018. "When knowledge is power: Evidence from the municipal bond market," Journal of Accounting and Economics, Elsevier, vol. 65(1), pages 109-128.
    15. Kurmann, André, 2014. "Holdups and overinvestment in capital markets," Journal of Economic Theory, Elsevier, vol. 151(C), pages 88-113.
    16. Shujing Li & Jiaping Qiu, 2014. "Financial Product Differentiation over the State Space in the Mutual Fund Industry," Management Science, INFORMS, vol. 60(2), pages 508-520, February.
    17. Andrikopoulos, Andreas, 2015. "Truth and financial economics: A review and assessment," International Review of Financial Analysis, Elsevier, vol. 39(C), pages 186-195.
    18. Schultz, Paul, 2012. "The market for new issues of municipal bonds: The roles of transparency and limited access to retail investors," Journal of Financial Economics, Elsevier, vol. 106(3), pages 492-512.
    19. Antoniou, Fabio & Fiocco, Raffaele & Guo, Dongyu, 2017. "Asymmetric price adjustments: A supply side approach," International Journal of Industrial Organization, Elsevier, vol. 50(C), pages 335-360.
    20. Renata Karkowska, 2012. "The economic costs of economic risk in the financial market (Koszty ekonomiczne ryzyka systemowego na rynku finansowym)," Problemy Zarzadzania, University of Warsaw, Faculty of Management, vol. 10(39), pages 33-53.
    21. Di Maggio, Marco & Kermani, Amir & Song, Zhaogang, 2017. "The value of trading relations in turbulent times," Journal of Financial Economics, Elsevier, vol. 124(2), pages 266-284.
    22. Marsch, I. & Wagner, W.B., 2012. "Why is Price Discovery in Credit Default Swap Markets News-Specific?," Other publications TiSEM 9c18cb4a-9339-4b03-be1f-7, Tilburg University, School of Economics and Management.
    23. Song Han & Alan G. Huang & Madhu Kalimipalli & Ke Wang, 2018. "Information and Liquidity of OTC Securities : Evidence from Public Registration of Rule 144A Bonds," Finance and Economics Discussion Series 2018-061, Board of Governors of the Federal Reserve System (U.S.).
    24. Paulo Pereira da Silva & Carlos Vieira & Isabel Vieira, 2018. "Central clearing and CDS market quality," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 38(6), pages 731-753, June.

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