Trading Ahead of Treasury Auctions

Abstract

I develop a model explaining the gradual price decrease observed ahead of anticipated asset sales, such as Treasury auctions. In the model, risk-averse investors expect an increase in the net supply of a risky asset, about which they have a noisy signal. They face a trade-off between hedging the noise with long positions, and speculating with short positions. As a result of hedging, the equilibrium price is above the expected price. As the sale approaches, the noise decreases due to the arrival of information, investors hedge less, and the price decreases. I illustrate the relevance of the theory in the days preceding Italian Treasury issuances. I find that meetings between the Treasury and primary dealers explain a 2.4 bps yield increase.

Keywords: Anticipated supply shocks; Supply risk; Treasury auctions; Market making

JEL Classification: G11, G12, E43