Does Asset Supply Affect Asset Prices? Evidence from the Agency Bond Market
42 Pages Posted: 26 Jan 2008 Last revised: 21 Mar 2009
Date Written: March 16, 2008
I examine the effect of a change in the relative supply of bonds issued by the Government Sponsored Enterprises (Fannie Mae and Freddie Mac) on their relative prices. I find that Fannie Mae spreads are tighter than Freddie Mac spreads after an exogenous negative supply shock to Fannie Mae bonds resulting from an undercapitalization announcement. Moreover, a decrease in issuance of Fannie Mae bonds after this event is associated with a decrease in Fannie Mae spreads relative to Freddie Mac spreads, but issuance volume and spreads are not positively related in the rest of the sample. As expected, this supply shock affected the short end of the term structure more than the long end. Collectively, these findings provide evidence that supply of financial assets affects prices, implying that the demand curve for financial assets is not perfectly elastic.
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