DP13345 Over-the-Counter Market Frictions and Yield Spread Changes

Author(s):	Nils Friewald, Florian Nagler
Publication Date:	November 2018
Keyword(s):	Corporate bond market, dealer market, intermediation frictions, Over-the-counter market, yield spread changes
JEL(s):	G10, G12, G20
Programme Areas:	Financial Economics
Link to this Page:	cepr.org/active/publications/discussion_papers/dp.php?dpno=13345

We empirically study whether systematic over-the-counter (OTC) market frictions affect the large unexplained common factor in yield spread changes. Using transactions data on U.S. corporate bonds, we show that measures of marketwide inventory, search, and bargaining frictions reduce the unexplained common component by 19 percentage points. Systematic OTC frictions substantially improve the explanatory power of yield spread changes and account for one-third of their total explained variation. Inventory frictions are equally important in explaining the dynamics of yield spread changes as search and bargaining frictions combined. Our findings support the implications of leading theories of intermediation frictions in OTC markets.