Bond market intermediation and the Role of Repo

Abstract

This paper models the important role that repurchase agreements (repos) play in bond market intermediation. Not only do repos allow dealers to finance their activities, but they also increase dealers' ability to satisfy levered client demands without having to adjust their holdings of risky assets. In effect, the ability to borrow specific assets for delivery allows dealers to source large quantity of assets without taking ownership of them. Larger levered client orders imply larger asset borrowing demands, thus increasing the borrowing cost for the asset (i.e., repo * This paper was previously circulated under the title "Bond Market Liquidity and the Role of Repo." We thank Erik Heitfield, Jean-David Sigaux, and participants at the 12th Annual Central Bank Conference on Market Microstructure of Financial Markets for their helpful feedback. The views of this paper are solely the responsibility of the authors and should not be interpreted as reflecting the views of the Board of Governors of the Federal Reserve System or of any other person associated with the Federal Reserve System. Federal Reserve Board, 20th St. and Constitution

Collateral Scarcity and Market Functioning: Insights from the Eurosystem Securities Lending Facilities

“…This translates into a close to 5% decline in the bond's bid-ask spread relative to the pre-period sample mean of 12.63 basis points. The effect is consistent with the theoretical results of Huh and Infante (2021) and suggests that lower specialness indeed translates into higher cash market liquidity because dealers now face lower intermediation costs in case they have to source the bond from the repo market.…”

“…This overall increase in collateral leads to a tightening of specialness spreads. As Huh and Infante (2021) show in a theoretical model, the specialness of a bond can be regarded as a cost for dealers who intermediate cash market transactions in the same bond. Lower levels of specialness are passed on to customers through lower bid-ask spreads.…”

Central bank liquidity facilities and market making

“…In practice, dealers often finance bond purchases through repo transactions (Huh and Infante 2021). We treat dealers' inventories as in Cimon and Garriott (2019) and assume that net dealer holdings (I + B n − S n ) are financed through leveraged repo transactions.…”

Repo rates as reference interest rates: testing the expectations hypothesis of the term structure of interest rates

“…Bottazzi, Luque and Páscoa (2012) examine how securities markets and repo markets coexist within the general economic equilibrium. Huh and Infante (2017) point to the importance of the role of repo transactions in brokerage in the securities market. The components of the difference between repo rates and rates on unsecured loans are empirically analyzed by Nyborg and Rösler (2019), using data on general repo rates on overnight transactions.…”