Abstract

https://ssrn.com/abstract=2895316
 


 



Bond Market Intermediation and the Role of Repo


Yesol Huh


Board of Governors of the Federal Reserve System - Division of Research and Statistics

Sebastian Infante


Federal Reserve Board - Division of Monetary Affairs

2017-01

FEDS Working Paper No. 2017-003

Abstract:     
This paper models the important role that repurchase agreements (repos) play in bond market intermediation. Not only do repos allow dealers to finance their activities, but they also increase dealers' ability to satisfy levered client demands without having to adjust their holdings of risky assets. In effect, the ability to borrow specific assets for delivery allows dealers to source large quantity of assets without taking ownership of them. Larger levered client orders imply larger asset borrowing demands, thus increasing the borrowing cost for the asset (i.e., repo specialness). Dealers pass on the higher intermediation cost to their clients in the form of higher bid-ask spreads. Although this method of intermediation is optimal, the use of repos significantly increases dealers' balance sheets. Limiting one dealer's balance sheet leverage, leaving all else equal, reduces the affected dealer's market making abilities and increases his bid-ask spreads. The equilibrium effect of limiting all dealers' balance sheet leverage on bid-ask spreads is unclear, and depends on the intensity of clients' demand and securities lenders' sensitivity to repo specialness.

Number of Pages in PDF File: 45

Keywords: Market liquidity, Financial services and intermediation, Repo, Specialness, U.S. Treasury market

JEL Classification: G2, G24, G28


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Date posted: January 8, 2017  

Suggested Citation

Huh, Yesol and Infante, Sebastian, Bond Market Intermediation and the Role of Repo (2017-01). FEDS Working Paper No. 2017-003. Available at SSRN: https://ssrn.com/abstract=2895316 or http://dx.doi.org/10.17016/FEDS.2017.003

Contact Information

Yesol Huh (Contact Author)
Board of Governors of the Federal Reserve System - Division of Research and Statistics ( email )
20th and C Streets, NW
Washington, DC 20551
United States
(202) 973-6943 (Phone)
HOME PAGE: http://sites.google.com/site/yesolhuh
Sebastian Infante
Federal Reserve Board - Division of Monetary Affairs ( email )
20th and C Streets, NW
Washington, DC 20551
United States
HOME PAGE: http://sites.google.com/site/sebinfante/home
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