Knowledge that Transforms

I demonstrate empirically that corporate bond dealers mitigate adverse selection risk by passing potentially informed transactions to institutional investors. I contrast price reversals following days with abnormal trading volume across bonds with different information asymmetry. In informed trading, the part of reversal specific to high-volume days should increase with information asymmetry. In uninformed trading, there is no such effect. Following high-volume days when investors provide liquidity, the reversals are consistent with the former case. When dealers provide liquidity, I observe the latter. The results suggest that the informational content of bond prices is higher when dealers do not take inventory.

Proposition 2 in Chandrasekhar et al. (2020) characterizes when imitation is optimal in a discrete-time setup where all agents are myopic Bayesian and this is common knowledge. In this note, we provide a correction to this result, where the condition for imitation to be optimal is stronger than in the original result.