What Makes Dealers Central? Evidence from Credit Interdealer Networks

We present a novel method for identifying the effect of search costs, risk appetite, and skill in explaining the differences between core and periphery dealers in the U.S. corporate bond market. Using a hand-constructed dataset that matches the trading activity of credit dealers in corporate bonds and positions from trading in CDS markets, we investigate the interdealer network structure at the bond-issuer level across both markets. We analyze the mean, volatility, and skewness of market-making returns to test theoretical predictions on dealer centrality and the distribution of their profit. Bond dealer centrality is associated with greater skill and risk appetite. More central dealers appear to have significantly less negative skewness in their trading returns, indicative of their ability to avoid bad trades. Bond underwriters, who have a search advantage, exhibit even less negative skewness, but lower mean and volatility of profits. Taken together, the moments of trading returns reveal a dealer's role in a market. These findings inform our understanding of regulatory policies such as the Volcker rule which target dealer trading in OTC markets.