The Effects of Mandatory Transparency in Financial Market Design: Evidence from the Corporate Bond Market

Many financial markets have recently become subject to new regulations requiring transparency. This paper studies how mandatory transparency affects trading in the corporate bond market. In July 2002, TRACE began requiring the public dissemination of post-trade price and volume information for corporate bonds. Dissemination took place in Phases, with actively traded, investment grade bonds becoming transparent before thinly traded, high-yield bonds. Using new data and a differences-in-differences research design, we find that transparency causes a significant decrease in price dispersion for all bonds and a significant decrease in trading activity for some categories of bonds. The largest decrease in daily price standard deviation, 24.7%, and the largest decrease in trading activity, 41.3%, occurs for bonds in the final Phase, which consisted primarily of high-yield bonds. These results indicate that mandated transparency may help some investors and dealers through a decline in price dispersion, while harming others through a reduction in trading activity.