Price Discreteness and Dealers' Market Power in the OTC Markets

摘要

I fi find that municipal bonds trade frequently at rounded prices in the secondary market. Over 13.6% of customer trades are at whole dollar prices (the minimum tick is 0.001),and more than 40% of the rounded prices are at exactly $100. Prices also cluster at halves,quarters,eighths,tenths,etc. Rounding is more prominent in trades that are smaller in size and below par,and in bonds that have larger coupon,lower price volatility and higher trading frequency. All of these characterize bonds that have greater retail interest. Clustering is also prominent in bond yields. Yields are disproportionately distributed at rounded percentages. Surprisingly,I fi find that dealers' markups are highly rounded as well. This indicates that dealers set the asking price conditional on cost of purchase,and customers tend to accept prices without haggling. To explain the pervasiveness of clustering in prices,yields and dealers' markups,I propose a dealer discriminating rounding hypothesis. Dealers round prices di!erently against customers with heterogeneous bargaining power. I support this hypothesis both theoretically and empirically. A two-stage bargaining model is used to show how dealers will round price up more when their relative bargaining power is higher. Empirically,I show that buying at whole dollars costs the customer 45 cents more,and selling at whole dollars costs 25 cents more per $100 par bond. Dealers earn 35% more if they round on both the buy and sell sides.