A report published by the Municipal Securities Rulemaking Board Thursday identified yields and market volatility as key drivers of secondary market trading volume in the municipal securities market, which has seen a record number of trades in each of the past three years.
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"Both yields and market volatility, the prime focus of this paper, were found to be positively correlated with trading volume, which is not surprising given the rising trade volume, yields and volatility since early 2022 as a result of mounting inflation in the United States," the report titled What Drives Trading Volume in the Municipal Securities Market? A Study of Likely Factors said.
The correlations between yields, volatility and trading volume held up even after taking into account other possible contributing factors such as primary offering volume, "and the positive correlations are statistically significant," the research report said.
"It should be noted that there may be other non-measurable factors that could also influence trading volume, for example, technological advancement and shifting investment preferences such as increased use of SMAs and ETFs by individual investors, which this paper cannot validate without the relevant data," the report said.
In 2024, the municipal securities secondary market saw a record number of trades for the third year in a row since at least 2005, which was when real-time trades began to be reported to the MSRB, the report said. While par value traded was lower in 2024 than in 2023 and 2022, par value traded in 2024 still was "noticeably higher than the average yearly level between 2011 and 2021," the report said.
The year 2021 registered the lowest number of trades and par value traded during the relevant period, according to the research report.
"Coinciding with the surging trading volume, tax-exempt benchmark yields and market volatility also increased between 2022 and 2024 when compared to the low levels in late 2020 and 2021," the report said.
The report also revealed a "notable shift" in investor trading patterns when yields were at their lowest levels. When tax-exempt 10-year yields were 1.5% or lower, less participation was seen from individual investors relative to institutional investors "as evidenced by significantly higher average trade sizes during those periods," the report said.
"Similarly, we found that odd-lot trades were more sensitive to yield movement than block trades, as the trading volume increase was more prominent for odd-lot trades than block trades as the yields moved up," the report said.
Institutional investors by comparison "were likely more sensitive to volatility movement than individual investors," as a regression analysis "showed that a hypothetical increase in volatility has more than twice as much impact on par value traded than on number of trades," the report said.
