December 12, 2019

An updated version of the paper "Dealer Inventory, Short Interest and Price Efficiency in the Corporate Bond Market" is now available. This is joint work with Yichao Zhu (ANU).

In this paper, we propose an equilibrium model of over-the-counter corporate bond trading with short selling, asymmetric information and dealer inventory costs. The model predicts that higher inventory costs impose implicit short-sale constraints on informed investors and are thus associated with lower price efficiency. We construct bond-level proxies for inventory costs and provide empirical evidence in support of the model’s prediction. Our findings suggest that tighter post-GFC regulation may have had unintended consequences for corporate bond market quality.