Inventory Management by Corporate Bond Dealers

Abstract

In over-the-counter markets, dealer willingness to hold inventory is synonymous with liquidity provision. Using actively-traded corporate bonds over 2005-2014, I show that dealers often avoid taking bonds into inventory by prearranging trades. Dealers who take longer to unwind inventory prearrange more trades. Investors receive higher prices selling to dealers who prearrange trades and pay lower prices buying from them. Dealers unwind inventory mostly through interdealer trades. After the Volcker Rule was finalized, dealers were more reluctant to takes bonds into inventory, were more likely to offset trades within a day, and unwound inventory positions more quickly.