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Bond market intermediation and the Role of Repo

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  • Huh, Yesol
  • Infante, Sebastian

Abstract

We model the role that repurchase agreements (repos) play in bond market intermediation. Not only do repos allow dealers to finance their activities, but they also enable dealers to source assets without taking ownership. When the asset trades with repo specialness, i.e, when the associated repo rate is significantly below prevailing market rates, borrowing the asset is more expensive, resulting in higher bid-ask spreads. Limiting a single dealer’s leverage decreases its market-making abilities, so the dealer charges a higher bid-ask spread. However, limiting all dealers’ leverage reduces pressure on repo specialness, thus decreasing bid-ask spreads. More generally, this paper characterizes the importance of collateralized borrowing and lending for bond market intermediation, shows how frictions in repo markets can affect the underlying cash market liquidity, and underscores the importance of securities lending.

Suggested Citation

  • Huh, Yesol & Infante, Sebastian, 2021. "Bond market intermediation and the Role of Repo," Journal of Banking & Finance, Elsevier, vol. 122(C).
    • Handle: RePEc:eee:jbfina:v:122:y:2021:i:c:s0378426620302612
    DOI: 10.1016/j.jbankfin.2020.105999
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    Citations

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    Cited by:

    1. Scheicher, Martin, 2023. "Intermediation in US and EU bond and swap markets: stylised facts, trends and impact of the coronavirus (COVID-19) crisis in March 2020," ESRB Occasional Paper Series 24, European Systemic Risk Board.
    2. Eisenschmidt, Jens & Ma, Yiming & Zhang, Anthony Lee, 2024. "Monetary policy transmission in segmented markets," Journal of Financial Economics, Elsevier, vol. 151(C).
    3. Valseth, Siri, 2023. "Repo market frictions and intermediation in electronic bond markets," UiS Working Papers in Economics and Finance 2023/1, University of Stavanger.
    4. Greppmair, Stefan & Jank, Stephan, 2023. "Collateral scarcity and market functioning: Insights from the eurosystem securities lending facilities," Discussion Papers 31/2023, Deutsche Bundesbank.
    5. Cimon, David A. & Walton, Adrian, 2024. "Central bank liquidity facilities and market making," Journal of Banking & Finance, Elsevier, vol. 162(C).
    6. Fabienne Schneider, 2024. "On-the-run Premia, Settlement Fails, and Central Bank Access," Working Papers 24.05, Swiss National Bank, Study Center Gerzensee.
    7. Jean‐Edouard Colliard & Thierry Foucault & Peter Hoffmann, 2021. "Inventory Management, Dealers' Connections, and Prices in Over‐the‐Counter Markets," Journal of Finance, American Finance Association, vol. 76(5), pages 2199-2247, October.
    8. Carrera de Souza, Tomás & Hudepohl, Tom, 2024. "Frictions in scaling up central bank balance sheet policies: How Eurosystem asset purchases impact the repo market," Journal of Banking & Finance, Elsevier, vol. 158(C).
    9. Marco Macchiavelli & Xing (Alex) Zhou, 2022. "Funding Liquidity and Market Liquidity: The Broker-Dealer Perspective," Management Science, INFORMS, vol. 68(5), pages 3379-3398, May.

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    More about this item

    Keywords

    Market liquidity; Repo; Intermediation; Regulation; Treasury market;
    All these keywords.

    JEL classification:

    • G2 - Financial Economics - - Financial Institutions and Services
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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