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

Abstract

We propose a model in which assets with identical cash flows can trade at different prices.Agents enter into an infinite-horizon, steady-state market to establish long or short positions.Both the spot and the asset-lending market operate through search. Short-sellers can endogenously concentrate in one asset because of search externalities and the constraint that they must deliver the asset they borrowed. As a result, that asset enjoys both 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.

Trading dynamics in decentralized markets with adverse selection

“…In addition, the correlation of endowments with asset returns may differ across agents. The current formulation is a reducedform representation of such differences; see Duffie et al (2007), Vayanos andWeill (2008), andGârleanu (2009).…”

The Same Bond at Different Prices: Identifying Search Frictions and Selling Pressures

“…Biais and Weill (2009) study order book dynamics by letting investors place an order in a limit order book instead of trading directly, but as in the DGP05 model investors make contact with the market at random times. Vayanos and Weill (2008), Vayanos and Wang (2007) and Weill (2008) extend the number of assets in the economy and derive crosssectional implications for expected returns. Gârleanu (2009) and Lagos and Rocheteau (2009) ease the restriction in DGP05 that asset holdings are 0 or 1 and find that trading volume increases when counterparties find each other more easily.…”

Pricing and Liquidity in Decentralized Asset Markets

“…These assumptions give rise to my reduced-form speci…cation, up to a suitable …rst-order approximation. See Du¢ e et al (2007), Vayanos and Weill (2008), and Gârleanu (2009) for a similar derivation.…”

“…The early models in this literature, such as Du¢ e, Gârleanu, and Pedersen (2007), Weill (2008), and Vayanos and Weill (2008), 5 studied theories of fully decentralized markets in a random search and bilateral bargaining environment and used these theories to present a better understanding of the individual and aggregate implications of distinctively non-Walrasian features of those markets. These models maintain tractability by limiting the investors to two asset positions, 0 or 1.…”