Bond Market Microstructure And Market Maker System: The Inter-bank Market Theory And Empirical

The market microstructure theory, which is undergoing a fast development, is one of the emerging branches of finance. It has penetrated into various fields in finance and enhanced the understanding of the financial market micro-operation in theories. A great deal of research has manifested that market microstructure is directly relevant to the realization of the security markets' function and the promotion of the market operation quality. It also has a profound impact on the liquidity, volatility, effectiveness, transaction cost, etc.From the perspective of scale, the interbank bond market, which composed the main body of domestic bond market, is the largest security market in China. By 2005, the transaction volume (including repos) reached 22.9 trillion RMB, which was 9 times as much as the volume in the exchange. Meanwhile, the stock of bond was over 6.6 trillion, 17 times as much as the volume in the exchange. From the perspective of transaction mechanism, the inquire mechanism is still the overwhelming mechanism in our domestic interbank bond market with the market maker mechanism as an assistant. This situation is totally different from the auction mechanism in the exchange market. Specificly, the interbank bond market is the first domestic market which adopted the market maker system. The accumulated operation data and experiences of nearly 5 years offer us a valuable sample and case for research.Therefore, the research on microstructure of the interbank bond market has profound theoretical and practical meanings. From one hand, it could offer references to the design and optimization of the market transaction mechanism. On the other hand, it can give evidence to the applicability of market maker mechanism, which could improve the diversity of the transaction mechanisms, in our financial market. However, so far, the study on this topic is still in its beginning stage in China. The existing literature mainly focused on the stock market under auction mechanism while there is a lack of systemic research on bond market microstructure and the market maker system. That's why this article came into being.In this dissertation, 4 questions will be answered theoretically. First, what is the difference between stock market and bond market and why did the market maker system take the lead in the financial markets all over the world? Second, from theoretical point of view, what is the function and effect, both positive and negative, the market maker mechanism bring to bond market. Third, in China's practice, what is the impact of market maker system to the liquidity, stability, effectiveness, transaction cost, etc.? Fourth, how can we assess the market maker system in the interbank bond market and is it the right development orientation of our bond market? Based on the four questions above, this dissertation had done a systemic research, which is extended from general to special, from logical to empirical, from abstract to specific, on the bond market microstructure and market maker system with the study on market maker system as a main line.Firstly, under the framework of market microstructure theory, I analyzed the features of bond market microstructure and the transaction mechanism. Also, I pointed out that the OTC transaction and market maker system are the mainstream of bond market transaction. Then, I studied the status and features of today's interbank bond market in China and done a comparison between auction mechanism and market maker mechanism. In order to focus on the analysis of promotion of liquidity, I made use of turnover and bid-ask spread as two main indicators to exam the liquidity of interbank bond market. According to the comparison with foreign counterpart, I drew the conclusion that the liquidity in our market is much lower, resulting in the need of further development. Moreover, by adopting the general theory of market microstructure, this article also made an analysis of the impact of market maker system, which was introduced into interbank bond market, to the liquidity, stability, effectiveness, transaction cost, etc. of the market.Based on the theoretical analysis, this article made use of the high frequency data of two-way quote in interbank bond market to do an empirical analysis on the market maker behavior and the market effect with the help of proper econometric methods. The main conclusions are: First, the pattern of the in-week spread motion showed as a W curve, where as the ANOVA showed that the difference of in-week spread is not statistically significant. Second, there are five factors which influence the spread in interbank bond market. The volatility, remain maturity and the index of market are positively relevant to spread. Where as the daily volume of bonds and the issue scale are negatively relevant to spread. Third, the market makers contribute a lot to the price discovery of bonds in the interbank bond market. But their contribution to the stability of the marker is not significant.At the end of this dissertation, relevant policy suggestions are given in accord with the existing problems in our interbank bond market and the experiences from developed countries.To sum up, the basic conclusions of this dissertation are as follows. Compared with the dominant auction mechanism of interbank bond market at present, the market maker mechanism lowered the transaction cost, promoted the efficiency and liquidity of market. Generally speaking, the market maker mechanism does have an edge over auction mechanism and should be the orientation for further development and optimization of our interbank bond market.