Liquidity Shocks, Market Maker Turnover, and Bidding Behavior in Treasury Auctions

Abstract

We use bid data from Argentinian Treasury bill auctions from 1996 to 2000 to study how banks' balance sheet and past performance affect bidding behavior. Exploiting variation in regulations for market making activity we show that when banks fear losing their market maker status, they bid more aggressively. They also bid more aggressively for existing securities that are reissued when the regulation tightens the requirements for secondary market participation. Consistent with regulations which imply that auctioned securities are not a prime source of liquidity, we find that banks which face liquidity needs bid less aggressively for them. A novel implication of our results is that in institutional settings that feature turnover of market makers, bidding behavior should be modeled in a dynamic setting. We introduce a dynamic model and show that static estimates over-predict true valuations when market makers may lose their status.

Keywords: Treasury Auctions; Multi-unit Auctions; Structural Estimation; Bidding Behavior; Balance-sheet; Data; Market Making

JEL Classification: D44; G12; G21; L10; L13