Y2k Options and the Liquidity Premium in Treasury Bond Markets

40 Pages Posted: 1 Nov 2006

See all articles by Zhenyu Wang

Zhenyu Wang

Indiana University, Kelley School of Business

Suresh M. Sundaresan

Columbia University - Columbia Business School, Finance

Date Written: November 2006

Abstract

Financial institutions around the world expected the millennium date change (Y2K) to cause an aggregate liquidity shortage. Responding to concerns about this liquidity shortage, the Federal Reserve Bank of New York auctioned Y2K options to primary dealers. The options gave the dealers the right to borrow from the Fed at a predetermined interest rate. The implied volatilities of Y2K options and the aggressiveness of demand for these instruments reveal that the Fed's action eased the fears of bond dealers, contributing to a drop in the liquidity premium of Treasury securities. Our analysis shows the link between the microstructure of government debt prices and the central bank's provision of liquidity. The use of Y2K options and their effect on the liquidity premium broadly conform to the economic theory and practice of the public provision of private liquidity.

Keywords: Y2K Options, liquidity, treasury bonds

JEL Classification: G1, G13, G18

Suggested Citation

Wang, Zhenyu and Sundaresan, Suresh M., Y2k Options and the Liquidity Premium in Treasury Bond Markets (November 2006). FRB of New York Staff Report No. 266, Available at SSRN: https://ssrn.com/abstract=941706 or http://dx.doi.org/10.2139/ssrn.941706

Zhenyu Wang (Contact Author)

Indiana University, Kelley School of Business ( email )

1309 E. 10th St.
Bloomington, IN 47405
United States

HOME PAGE: http://www.kelley.iu.edu/Finance/Faculty/page12594.cfm?ID=37555

Suresh M. Sundaresan

Columbia University - Columbia Business School, Finance ( email )

3022 Broadway
New York, NY 10027
United States
212-854-4423 (Phone)
212-316-9180 (Fax)

HOME PAGE: http://www0.gsb.columbia.edu/faculty/ssundaresan/

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