Y2k Options and the Liquidity Premium in Treasury Markets

Posted: 17 Mar 2009

See all articles by Suresh M. Sundaresan

Suresh M. Sundaresan

Columbia University - Columbia Business School, Finance

Zhenyu Wang

Indiana University, Kelley School of Business

Date Written: March 2009

Abstract

Financial institutions around the world expected the millennium date change (Y2K) to cause an aggregate liquidity shortage. Responding to the concern, the Federal Reserve Bank of New York auctioned Y2K options to primary dealers. The options gave the dealers the right to borrow from the Fed at a predetermined interest rate. Using the implied volatilities of Y2K options and the on/off-the-run spread, we demonstrate that the Fed's action eased the fears of bond dealers, contributing to a drop in the liquidity premium of Treasury securities. Our analysis shows the link between the microstructure of government debt markets and the central bank's provision of liquidity. We argue that Y2K options and their effects on liquidity premium broadly conform to the economic theory on public provision of private liquidity.

Keywords: G1, G12, G18

Suggested Citation

Sundaresan, Suresh M. and Wang, Zhenyu, Y2k Options and the Liquidity Premium in Treasury Markets (March 2009). The Review of Financial Studies, Vol. 22, Issue 3, pp. 1021-1056, 2009, Available at SSRN: https://ssrn.com/abstract=1359521 or http://dx.doi.org/hhn005

Suresh M. Sundaresan (Contact Author)

Columbia University - Columbia Business School, Finance ( email )

3022 Broadway
New York, NY 10027
United States
212-854-4423 (Phone)
212-316-9180 (Fax)

HOME PAGE: http://www0.gsb.columbia.edu/faculty/ssundaresan/

Zhenyu Wang

Indiana University, Kelley School of Business ( email )

1309 E. 10th St.
Bloomington, IN 47405
United States

HOME PAGE: http://www.kelley.iu.edu/Finance/Faculty/page12594.cfm?ID=37555

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