| Abstract: |
Trading in fixed-income markets is traditionally dominated by large institutional investors, such as pension and insurance funds. This concentration results in a narrow investor base that can impair market quality and liquidity. While research in equity markets suggests that expanding the investor base, particularly through retail participation, improves market quality, evidence for corporate bonds remains scarce. Our study addresses this gap by examining a unique regulatory event: the reduction of minimum trading units (MTU) for contingent convertible (CoCo) bonds on the Tel-Aviv Stock Exchange (TASE) on January 2024. All bonds are traded on TASE in a limit order book mechanism, which provides a deep and transparent environment for bond trading. However, prior to the event, the MTU for CoCo was significantly higher than for other bonds, aimed to preclude the trading of retail investors.
The empirical results indicate that the MTU reduction significantly transformed the trading landscape. Following the implementation, mean daily turnover for CoCo bonds increased by over 240%, while the number of daily transactions grew nearly fourfold. Simultaneously, the mean transaction size decreased by approximately 49%, providing clear evidence of the entry of smaller, retail-oriented traders. This surge in activity directly enhanced market quality; the proportion of zero-trading days for CoCo bonds plummeted from 38.9% to 14.3%, indicating a substantial improvement in daily tradability. To confirm that theses patterns do not stem from broader industry or market-wide trends, we examined two control groups: the first consists of matched non-financial corporate bonds with similar ratings and durations, and the second consisting of regular (non-CoCo) bank bonds. Both control groups did not demonstrate similar changes in their trading activity.
The price reaction surrounding the event suggests that the market capitalized the benefits of improved liquidity only when the constraint was actually relaxed. While the initial announcement of the policy yielded no significant abnormal returns, the actual implementation date was associated with positive cumulative abnormal returns (CAR) of 0.4% to 0.5%. This suggests that the reduction in trading frictions led to a permanent shift in valuation as the bonds became accessible to a wider array of participants.
This study offers substantial originality as the first to examine MTU reduction within the corporate bond asset class. It also provides critical evidence for global regulators in the US and Europe who are currently debating whether to restrict or expand retail access to complex hybrid financial instruments. The findings demonstrate that lowering trading hurdles can enhance market efficiency and liquidity. |