An Empirical Model for Spillover Effects in Price Discovery with Application to the European Bond Market

This paper examines spillover effects caused when market participants trade different financial instruments in a single operation. We develop and test an extended model for cross-correlation in the trading processes of different assets on the European bond market. We find a significant dependency of mid-quote changes and the order flow of the bonds with respect to the market as whole. We also show that trading intensity in the market affects the dynamics of the order flow of particular fixed income instruments. More precisely, a buy (sell) order is less likely to be followed by a buy (sell) order if the market is trading intensively. We explain this effect as an inventory problem where the volatility of prices forces market makers to improve trades in the opposite direction from the current order flow