Cover Risk

Abstract

Cover risk denotes the risk of short sellers being unable to deliver. Large-scale asset purchases (LSAPs) by the central bank substantially weaken borrowers' bargaining power in the government bond market. We estimate a variety of cover risk measures, such as the non-execution probability of repurchase agreement (repo) orders, rate concessions, and search duration, to test search-theoretic models' prediction. We find cover risk rises as the central bank holds larger proportions of a bond. Despite the bid quotes of unfilled orders being four times higher than those of filled orders, counterparties cannot be found. Aggressive LSAPs weaken dealers' market-making capability

Keywords: Sovereign bonds, short position, large-scale asset purchase, scarcity, repo