We document a pecking order of transaction costs in the interdealer market for German sovereign bonds, where three trading protocols coexist. Dealers can trade over-the-counter, either bilaterally or via brokers, as well as on an exchange. Trading on the exchange is more expensive than OTC, and broker-intermediated are more costly than bilateral OTC trades. The existence of an OTC discount is diﬃcult to square with theories centred around search-and-bargaining frictions, but is in line with models of hybrid markets based on information frictions. Consistently, we show that dealers’ private information impacts their choice of trading protocol and that the pecking order of transaction costs is aligned with the informational content of order ﬂows across protocols. Search-and-bargaining as well as information proxies explain diﬀerences in OTC discount within protocols. A realistic description of hybrid markets thus requires both types of frictions.
SAFE Working Paper No. 298