In this article, we survey the literature that studies fixed-income trading rules and outcomes, including Treasury securities, corporate and municipal bonds, and structured credit products. We compare and contrast the microstructure and regulation of fixed-income markets with equity markets. We highlight the nature of over-the-counter trading in the face of search costs and the associated slow evolution of electronically facilitated intermediation. We discuss the databases available to study fixed-income microstructure, as well as measures and determinants of trading costs, and the important roles dealer networks and limited transparency play. We also highlight unresolved issues.

We provide a theoretical rationale for dealer objections to ex post transparency in over-the-counter markets. Disclosure of the terms of a transaction conveys information possessed by the dealer about the asset quality and reduces the dealer’s rents when she disposes of the inventory in a second transaction. We show that costly signaling in a transparent market benefits investors through lower spreads and higher volume. Dealers may also gain from transparency despite lower spreads when potential gains from trade are small or adverse selection is high, because in those circumstances higher volume offsets smaller spreads for dealer profits.

We show short selling in corporate bonds forecasts future bond returns. Short selling predicts bond returns where private information is more likely, in high-yield bonds, particularly after Lehman Brothers’ collapse of 2008. Short selling predicts returns following both high and low past bond returns. This, together with short selling increasing following past buying order imbalances, suggests short sellers trade against price pressures as well as trade on information. Short selling predicts bond returns both in the individual bonds that are shorted and in other bonds by the same issuer. Past stock returns and short selling in stocks predict bond returns but do not eliminate bond short selling predicting bond returns. Bond short selling does not predict the issuer’s stock returns. These results show bond short sellers contribute to efficient bond prices and that short sellers’ information flows from stocks to bonds but not from bonds to stocks.

We study the impact of permanent open market operations (POMOs) by the Federal Reserve on U.S. Treasury market liquidity. Using a parsimonious model of speculative trading, we conjecture that i) this form of government intervention improves market liquidity, contrary to conclusions drawn by existing literature; and ii) the extent of this improvement depends on the market’s information environment. Evidence from a novel sample of Federal Reserve POMOs during the 2000s indicates that bid–ask spreads of on-the-run Treasury securities decline when POMOs are executed, by an amount increasing in proxies for information heterogeneity among speculators, fundamental volatility, and POMO policy uncertainty, consistent with our model.

We use proprietary transaction data on interest rate swaps to assess the effects of centralized trading, as mandated by Dodd–Frank, on market quality. Contracts with the most extensive centralized trading see liquidity metrics improve by between 12% and 19% relative to those of a control group. This is driven by a clear increase in competition between dealers, particularly in U.S. markets. Additionally, centralized trading has caused interdealer trading in EUR swap markets to migrate from the United States to Europe. This is consistent with swap dealers attempting to avoid being captured by the trade mandate in order to maintain market power.

We study quantitative easing (QE) policies from a microstructure perspective, drawing on intraday transaction-level data for German bonds (purchased under the Eurosystem’s QE program). An initial analysis of purchase decisions reveals that portfolio managers consider liquidity and the scarcity of securities in repo markets. Suggestive of significant flow effects, we detect price impacts of purchases at high and low frequencies. We find the impact on market liquidity and functioning to be ambiguous. A higher purchase volume lowers transaction costs but has an adverse impact on order-book depth. The price impact varies with market conditions and is higher for more illiquid bonds.

We investigate the role of extreme positive payoffs in the distribution of monthly fund returns in investors’ mutual fund preferences. We document a positive and significant relationship between the maximum style-adjusted monthly return (MAX) and future fund flows. The relationship is robust to controlling for average performance, volatility, skewness, and various other fund characteristics. Our findings are consistent with the notion that fund investors overweight the probability of high payoff states in the past return distribution. We further show that MAX is not a useful predictor of future performance and that an increase in a fund’s visibility does not explain our findings.

We use variation in real estate prices as exogenous shocks to firms’ debt capacity to study the causal effect of financial flexibility on payout policy. We show that an increase in financial flexibility results in higher dividends, share repurchases, and payout flexibility. We find that a 1-standard-deviation increase in a firms’ collateral value results in 0.26- and 0.55-percentage-point increases in nondiscretionary and discretionary payouts, respectively. This effect is stronger for firms with few investment opportunities. Moreover, highly leveraged firms are more likely to cut dividends in response to a sharp decrease in their financial flexibility.

Does option-based compensation affect payout policy? To address this question, we examine the adoption of mandatory expensing of stock options. Our identification strategy exploits the fact that the reduction in option-based compensation after the accounting change varies with the firm-specific expected accounting impact. Across a battery of tests, we do not find that (accounting-driven) reductions in option-based pay cause dividends to increase or repurchases to decrease. Our results contrast with the widely held belief that option-based pay has a significant causal influence on payout policy and cast doubts on its role in the shift from dividends to repurchases.

Using a fast numerical technique, we investigate a large database of investors’ suboptimal nonexercise of short-maturity American call options on dividend-paying stocks listed on the Dow Jones. The correct modeling of the discrete dividend is essential for a correct calculation of the early exercise boundary, as confirmed by theoretical insights. Pricing with stochastic volatility and jumps instead of the Black–Scholes–Merton benchmark cuts the amount lost by investors through suboptimal exercise by one-quarter. The remaining three-quarters are largely unexplained by transaction fees and may be interpreted as an opportunity cost for the investors to monitor optimal exercise.