Bank for International Settlements estimates OTC trading frictions causing 2.4% welfare loss in UK government bonds and 5.0% in corporate bonds

The Bank for International Settlements published a working paper that develops and estimates a two-asset search-and-bargaining model of over-the-counter (OTC) trading to quantify trading frictions and associated welfare losses in UK government and corporate bond markets using transaction-level data and a matched set of clients active in both markets. The analysis finds materially larger trading delays and overall welfare losses in corporate bonds, with estimated welfare losses of 2.38% in government bonds and 5.05% in corporate bonds under normal conditions, driven mainly by search-related trading delays; estimates based on COVID-19 crisis data suggest the losses could more than double in stress. Using near-universe secondary-market data and common clients to control for selection, the paper estimates that the median client’s search time is less than five minutes for government bond trades versus about 45 minutes for corporate bonds, rising to about half a day and nearly 1.4 days respectively at the 75th percentile. Intermediation frictions contribute negligibly to welfare loss in government bonds and around 0.10% in corporate bonds in normal times, but crisis re-estimates imply welfare losses of 3.63% (government) and 11.35% (corporate), with intermediation frictions’ share in corporate bond welfare loss increasing to about 30%, highlighting fragility in the OTC market structure during turbulent periods.