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A Search-Based Theory of the On-the-Run Phenomenon

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Dimitri Vayanos
Pierre-Olivier Weill

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Abstract

We propose a model in which assets with identical cash flows can trade at different prices. Infinitely-lived agents can establish long positions in a search spot market, or short positions by first borrowing an asset in a search repo market. We show that short-sellers can endogenously concentrate in one asset because of search externalities and the constraint that they must deliver the asset they borrowed. That asset enjoys greater liquidity, measured by search times, and a higher lending fee ("specialness"). Liquidity and specialness translate into price premia that are consistent with no-arbitrage. We derive closed-form solutions for small frictions, and can generate price differentials in line with observed on-the-run premia.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 12670.

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Date of creation: Nov 2006
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Handle: RePEc:nbr:nberwo:12670

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D8 - Microeconomics - - Information, Knowledge, and Uncertainty
G1 - Financial Economics - - General Financial Markets

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References listed on IDEAS
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  1. Michael J. Fleming, 2002. "Are larger Treasury issues more liquid? Evidence from bill reopenings," Proceedings, Federal Reserve Bank of Cleveland, pages 707-739.
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  2. Amihud, Yakov & Mendelson, Haim, 1991. " Liquidity, Maturity, and the Yields on U.S. Treasury Securities," Journal of Finance, American Finance Association, vol. 46(4), pages 1411-25, September. [Downloadable!] (restricted)
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  1. Gara M. Afonso, 2008. "Liquidity and congestion," Staff Reports 349, Federal Reserve Bank of New York. [Downloadable!]
  2. Ricardo Lagos & Guillaume Rocheteau, 2008. "Liquidity in asset markets with search frictions," Staff Report 408, Federal Reserve Bank of Minneapolis. [Downloadable!]
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  3. Shoko Morimoto, 2009. "Asset markets can achieve efficiency in the directed search framework," Discussion Papers in Economics and Business 09-33, Osaka University, Graduate School of Economics and Osaka School of International Public Policy (OSIPP). [Downloadable!]
  4. Kajuth, Florian & Watzka, Sebastian, 2008. "Inflation expectations from index-linked bonds: Correcting for liquidity and inflation risk premia," Discussion Papers in Economics 4858, University of Munich, Department of Economics. [Downloadable!]
  5. Bruce Mizrach & Christopher J. Neely, 2007. "Information shares in the U.S. treasury market," Working Papers 2005-070, Federal Reserve Bank of St. Louis. [Downloadable!]
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  6. Ricardo Lagos & Guillaume Rocheteau, 2006. "Search in asset markets," Working Paper 0607, Federal Reserve Bank of Cleveland. [Downloadable!]
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  7. Bruno Biais & Pierre-Olivier Weill, 2009. "Liquidity Shocks and Order Book Dynamics," NBER Working Papers 15009, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  8. Bruce Mizrach & Christopher J. Neely, 2007. "The microstructure of the U.S. treasury market," Working Papers 2007-052, Federal Reserve Bank of St. Louis. [Downloadable!]
  9. Ricardo Lagos & Guillaume Rocheteau & Pierre-Olivier Weill, 2009. "Crises and Liquidity in Over-the-Counter Markets," NBER Working Papers 15414, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  10. Ricardo Lagos & Guillaume Rocheteau & Pierre-Olivier Weill, 2008. "Crashes and Recoveries in Illiquid Markets," NBER Working Papers 14119, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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