Dealers and the Dealer of Last Resort: Evidence from MBS Markets in the COVID-19 Crisis

50 Pages Posted: 21 Jul 2020 Last revised: 24 May 2021

See all articles by Jiakai Chen

Jiakai Chen

University of Hawaii

Haoyang Liu

Federal Reserve Bank of New York

Asani Sarkar

Federal Reserve Bank of New York

Zhaogang Song

Johns Hopkins University - Carey Business School

Date Written: July 1, 2020

Abstract

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

Chen, Jiakai and Liu, Haoyang and Sarkar, Asani and Song, Zhaogang, Dealers and the Dealer of Last Resort: Evidence from MBS Markets in the COVID-19 Crisis (July 1, 2020). FRB of New York Staff Report No. 933, Rev. May 2021, Available at SSRN: https://ssrn.com/abstract=3651462 or http://dx.doi.org/10.2139/ssrn.3651462

Jiakai Chen

University of Hawaii ( email )

Honolulu, HI 96822
United States

Haoyang Liu (Contact Author)

Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States

Asani Sarkar

Federal Reserve Bank of New York ( email )

Research Department
33 Liberty Street
New York, NY 10045
United States
212-720-8943 (Phone)
212-720-1582 (Fax)

HOME PAGE: http://www.newyorkfed.org/research/economists/sarkar/pub.html

Zhaogang Song

Johns Hopkins University - Carey Business School ( email )

100 International Drive
Baltimore, MD 21202
United States

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