Bond market structure and volatility

Abstract

We apply variance ratio methodologies to examine market quality in the US corporate bond market. We find that the open-to-open to close-to-close return variance ratio is greater than one suggesting that the corporate bond market is less efficient during the opening hours than during the closing hours. We show that the higher variance ratio at the open is related to the market power of dealers at the open and the sources of power are from lower cost of inventory, lower asymmetric information, and more flexibility to intermediate a trade. Dealers appear to exert less market power for bonds with low volume and credit rating. The results are consistent with dealers behaving strategically to unload risky assets and take on safer assets.