A Tale of Two Platforms: Dealer Intermediation in the European Sovereign Bond Market

Abstract

European sovereign bond trading occurs in a highly liquid inter-dealer market and a parallel dealer-customer market in which buy-side financial institutions request quotes from primary dealers. Synchronized price data from both market segments allow us to compare market quality. We find that customer transactions (i) are on average priced very favorably relative to the best inter-dealer quotes, (ii) feature a relatively high price dispersion at any given moment, and (iii) show less average quality deterioration under higher market volatility and bond maturity than the best inter-dealer quotes. We develop a simple dynamic model of dealer intermediation across markets that can account for these findings. The dealers’ inventory management concerns are shown to be an important determinant of customer transaction quality both in the model and in the data.

Keywords: Dealer Intermediation, Spread Determination, Adverse Selection, Market Segmentation