Portfolio Trading and Corporate Bond ETFs

ABSTRACT We document a strong connection between portfolio trading—a recent innovation in the corporate bond market—and corporate bond ETFs. Portfolio trading refers to the execution of a basket of bonds as a single unit of risk with a single market‐maker. Using a database of portfolio trades that we construct from TRACE, our trade‐level and portfolio‐level analyses identify two channels through which the use of bond ETFs allows market‐makers to price these trades more efficiently than comparable trades in individual securities. First, ETFs give market‐makers an effective tool for pricing and hedging portfolio risk. Second, ETFs provide an additional outlet for absorbing the risk that accumulates through portfolio trading.