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Over‐the‐Counter Market Frictions and Yield Spread Changes

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  • NILS FRIEWALD
  • FLORIAN NAGLER

Abstract

We empirically study whether systematic over‐the‐counter (OTC) market frictions drive the large unexplained common factor in yield spread changes. Using transaction data on U.S. corporate bonds, we find that marketwide inventory, search, and bargaining frictions explain 23.4% of the variation in the common component. Systematic OTC frictions thus substantially improve the explanatory power of yield spread changes and account for one‐third of their total explained variation. Search and bargaining frictions combined explain more in the common dynamics of yield spread changes than inventory frictions. Our findings support the implications of leading theories of intermediation frictions in OTC markets.

Suggested Citation

  • Nils Friewald & Florian Nagler, 2019. "Over‐the‐Counter Market Frictions and Yield Spread Changes," Journal of Finance, American Finance Association, vol. 74(6), pages 3217-3257, December.
    • Handle: RePEc:bla:jfinan:v:74:y:2019:i:6:p:3217-3257
    DOI: 10.1111/jofi.12827
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