Dealers and the Dealer of Last Resort: Evidence from MBS Markets in the COVID-19 Crisis
56 Pages Posted: 21 Jul 2020 Last revised: 6 Oct 2021
Date Written: July 1, 2020
We study price dislocations and liquidity provision by dealers and the Federal Reserve (Fed) as the “dealer of last resort” in agency MBS markets during the COVID-19 crisis. As customers sold MBS to “scramble for cash,” dealers provided liquidity by taking inventory in the cash market and hedging inventory risk in the forward market. The cash and forward prices diverged significantly beyond the difference in the quality of MBS traded on the two markets. The Fed first facilitated dealers’ inventory hedging and then took holdings off dealers’ inventory directly. The price dislocations began to revert only after the Fed’s latter action, when customer selling was still strong.
Keywords: arbitrage, cash, dealer, liquidity, MBS, specified pool, TBA
JEL Classification: D8, G2
Suggested Citation: Suggested Citation