OTC Discount

Authors: Calebe de Roure (Reserve Bank of Australia), Emanuel Mönch (Deutsche Bundesbank), Loriana Pelizzon (Goethe University, SAFE, and Universita' Ca' Foscari di Venezia), Michael Schneider (Deutsche Bundesbank and Scuola Normale Superiore Pisa)

Title: OTC Discount

Abstract: This paper studies venue choice and price dispersion in the market for German Bunds, the second most liquid sovereign bond market in the world. Dealers trade Bunds in a hybrid market setting with electronic centralized limit order books (on the leading interdealer exchange MTS) and in a dominant over-the-counter (OTC) segment. Using a unique regulatory dataset of OTC Bund transactions matched with the full limit order book and all trades on MTS, we show that the exchange provides an outside option to the OTC search process and, crucially, immediacy. Most OTC trades carry a discount relative to trading on the exchange, and OTC round-trip costs are on average up to 50% lower than on the MTS market. Moreover, OTC trades by dealers with access to the exchange are on average cheaper than those by non-MTS dealers. Our findings highlight the complementary roles played by centralized limit order book and OTC markets with important implications for the design and regulation of fixed-income trading.