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Anticipated and Repeated Shocks in Liquid Markets

38 Pages Posted: 15 Aug 2010 Last revised: 3 May 2013

Dong Lou

London School of Economics & Political Science (LSE); London School of Economics & Political Science (LSE) - Department of Finance

Hongjun Yan

Driehaus College of Business, DePaul University

Jinfan Zhang

International Monetary Fund

Date Written: May 2, 2013

Abstract

This paper examines how anticipated and frequently repeated shocks are absorbed in liquid financial markets. We show that Treasury security prices in the secondary market decrease significantly in the few days leading up to Treasury auctions and recover shortly thereafter, even though the time and amount of each auction are announced in advance. The issuance cost to the Treasury Department is estimated to be between 9 and 18 basis points of the auction size, or over half a billion dollars for note issuance alone in 2007, most of which can be attributed to the price pressure effect around auction days. These results are linked to dealers’ limited risk-bearing capacity and the imperfect capital mobility of end-investors, highlighting the important role of market frictions even in very liquid financial markets.

Keywords: Liquidity, Capital mobility, Supply shocks, Treasury auctions

JEL Classification: G12

Suggested Citation

Lou, Dong and Yan, Hongjun and Zhang, Jinfan, Anticipated and Repeated Shocks in Liquid Markets (May 2, 2013). Available at SSRN: https://ssrn.com/abstract=1659239 or http://dx.doi.org/10.2139/ssrn.1659239

Dong Lou

London School of Economics & Political Science (LSE) ( email )

Department of Finance
Houghton Street
London, WC2A 2AE
United Kingdom
+44 (0)207 1075360 (Phone)

HOME PAGE: http://personal.lse.ac.uk/loud/

London School of Economics & Political Science (LSE) - Department of Finance ( email )

Department of Finance
Houghton Street
London, WC2A 2AE
United Kingdom
+44 (0)207 1075360 (Phone)

HOME PAGE: http://personal.lse.ac.uk/loud/

Hongjun Yan (Contact Author)

Driehaus College of Business, DePaul University ( email )

1 East Jackson Blvd.
Chicago, IL 60604
United States

HOME PAGE: http://sites.google.com/site/hongjunyanhomepage/

Jinfan Zhang

International Monetary Fund ( email )

700 19th St NW
Washington, DC 20431
United States

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