Quantifying and Explaining the New-Issue
Premium in the Post-Glass–Steagall Corporate
Bond Market

Abstract

The authors document and rationalize the premium paid by bond issuers in the corporate bond markets. Changes in the bond market over the past 30 years have shifted the new-issue pricing risk from investors to banks and back to investors, with large institutional investors acting as a de facto adjunct underwriting group, and this process has required both capital commitment as well as a commitment to taking on unsystematic risk for which investors require compensation. The authors use the superior data prevalent in trades under the TRACE system to compute the new-issue premium (NIP) and relate the magnitude of that premium to predetermined economic variables: the level of the corporate bond spread; the future volatility of swap spreads; the prevailing value of unsystematic risk in the bond markets; the spread of the issuer to the Treasury market at time of issuance; and the tenor of the new bond issue. They then present a model for the required NIP based on compensation for information uncertainty and the bearing of unsystematic risk. In so doing, they also address the issues of oligopolistic pricing and wealth transfer that occur at time of issuance.