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Financial Asset Demand is Elastic: Evidence from New Issues of Federal Home Loan Bank Debt

49 Pages Posted: 15 Aug 2009 Last revised: 14 May 2011

Vladimir A. Atanasov

College of William and Mary - Mason School of Business

John J. Merrick Jr.

College of William and Mary - Mason School of Business

Date Written: May 11, 2011

Abstract

We estimate the slope of the demand curve for newly auctioned FHLB discount notes and investigate the impacts of arbitrage risk and heterogeneity of investor beliefs on demand elasticity. Our unique dataset of roughly 2,900 observations of two price-quantity pairs - the first from a pre-auction dealer survey, the second from actual auction results - provides the quantity shift necessary to identify demand. In contrast to previous findings of downward-sloping demand curves for equities, we show that demand for newly issued FHLB notes is nearly perfectly elastic during normal market conditions. We find, however, that frictions like arbitrage risk and, to a lesser extent, heterogeneity of investor beliefs negatively affect elasticity and explain the nearly 50% drop in elasticity observed during the recent financial crisis.

Keywords: debt auctions, demand elasticity, arbitrage risk, Federal Home Loan Bank

JEL Classification: D44, G21

Suggested Citation

Atanasov, Vladimir A. and Merrick, John J., Financial Asset Demand is Elastic: Evidence from New Issues of Federal Home Loan Bank Debt (May 11, 2011). Journal of Banking and Finance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1452910

Vladimir Atanasov (Contact Author)

College of William and Mary - Mason School of Business ( email )

P.O. Box 8795
Williamsburg, VA 23187-8795
United States

John Merrick

College of William and Mary - Mason School of Business ( email )

P.O. Box 8795
Williamsburg, VA 23187-8795
United States
757-221-2721 (Phone)
757-221-2937 (Fax)

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