Why Do Dealers Buy High and Sell Low? An Analysis of Persistent Crossing in Extremely Segmented Markets

We find that small buy trades of U.S. agency mortgage-backed securities (MBS) are priced 3%-8% lower than large sell trades. No such “crossing” exists in corporate bonds and agency debentures. We attribute the MBS price patterns to impediments to position aggregation in combination with investor suitability rules that disproportionately affect retail-sized trading and show in a model that classic market frictions cannot produce crossing. Our findings imply that valuations placed on securities affected by aggregation and suitability frictions should adjust for position size. Such securities include not only agency MBS, but also ABS, CMBS, CMOs, CLOs, and private-label RMBS.