Study On The Difference Of Market Bond Price Between Inter - Bank Market And Exchange

It has been a long time that same bonds have price spreads when trading at inter-bank bond market and the exchange bond market. Most of the previous literatures tried to explain such a phenomenon in terms of fixed market institutional factors, however, we note that the spreads of the same bonds not only exist in long term, but also have a time-varying characteristic, which can’t be ascribed merely to fixed institutional factors. In this paper, through the analysis of the104cross-market treasury bonds, we find that liquidity as a varying market factor could be the key to understanding why the price spreads between the two markets are time-varying.Firstly, we conducted a panel data analysis of104cross-market treasury bonds over the12months in2011and concluded that the spread is due to the asymmetrical compensation for liquidity risk. As a result of market segregation, exchange bond market has lower level of liquidity and higher liquidity risk compared to the inter-bank bond market, therefore, investors would ask for higher return when trading at the exchange bond market than that of the inter-bank bond market. So, asymmetry of liquidity risk compensation causes the existence of the spreads.Secondly, we use the return rate, liquidity and volatility over the period of2005-2011from the stock market, inter-bank bond market and exchange bond market to conduct a vector auto regression (VAR) analysis. We find that the stock market exerts an asymmetry effect on the two bond markets------as the volatility in stock market rises, the liquidity in inter-bank market would decrease more than that in exchange market, which leads to the squeezing gap of spreads between the two markets. To summarize, the bond spread would vary with the volatility in the stock market, so this is the cause of the time-varying characteristics of the bond spread.After these two steps, we have found a complete logical chain to explaining the price spreads of same bonds between two bond markets. At the end of this paper, we bring out our own analysis and recommendations on how to eliminate market segmentation, thereby reducing the liquidity difference between the two markets and the price difference, to improve the efficiency of financial markets.