Bond Losses and Systemic Risk

Abstract

This paper documents the existence of primary dealers' losses in Treasury bond markets and investigates how these losses affect financial stability. Using a novel data set, which tracks more than 2,350 primary-to-secondary transactions, we find that bond losses for primary dealers are prevalent, and were severe during the financial crisis. Our results indicate that liquidity constraints are a major source of bond losses observed in the secondary market. We also find that financial market instability is correlated with these losses. Using an alternating market experiment, we show that bond losses are higher under discriminatory auctions compared to uniform auctions release.

Keywords: Treasury Auctions, Bond Losses, Discriminatory vs Uniform-Price Auctions

JEL Classification: C57, C58, D44.