Information Flows in Trading Networks

Abstract

We study the informational value of trading networks in over-the-counter (OTC) markets. Using detailed transaction-level data from the corporate bond market, we show that investors with larger dealer trading networks make superior trading decisions before changes in credit fundamentals and yield better risk-adjusted performance. Our evidence indicates that an important mechanism for this result is that dealers reward their trading clients with private information. Consistent with this mechanism, we show that investors make superior trading decisions when they have trading relationships with dealers likely to have novel information. In addition, investors with trading relationships with deal-affiliated dealers transact more profitably before important merger and acquisition (M&A) deals are publicly announced. Collectively, our evidence highlights the importance of trading relationships for investors' private information acquisition.

Edward M. Watts

Assistant Professor of Accounting

Edward Watts is an Assistant Professor of Accounting at the Yale School of Management.