The importance of being special: Repo markets during the crisis

Abstract

We study how the Italian sovereign bond scarcity premia -specialness -in the repo market were affected by the European Central Bank (ECB)'s purchases during the Euro area sovereign debt crisis. We propose and calibrate a search-based dynamic model with a central bank acting as a buy-and-hold investor. Consistent with model predictions, ECB purchases drive specialness of targeted securities in combination with short-selling. Special benchmark bonds entail a positive cash premium but their market liquidity decreases when purchased by the ECB. Short-sellers were more likely to fail-to-deliver very special bonds while holders of these bonds were less inclined to pledge them as collateral to the ECB liquidity operations.JEL classification: E43, E51, G01, G12, G23.

Why Do Central Banks Make Public Announcements of Open Market Operations?

“…We confirm that indicators of borrowing demand and supply identified in the literature on the drivers of repo specialness are significant in predicting BoC operations in a security (Corradin and Maddaloni, 2020;D'Amico, Fan, and Kitsul, 2018;Fleming and Garbade, 2007). Bonds with larger effective supply have lower probability of experiencing BoC operations.…”

“…Since the BoC's stated policy is to use SLOs to alleviate undesirable shortages in the market for borrowing GoC securities, we use indicators of borrowing demand and supply in the expectations-formation stage. The supply of GoC securities is limited by their amount outstanding less that locked up in alternative uses (Corradin and Maddaloni, 2020;D'Amico, Fan, and Kitsul, 2018). Panel B of Table 8 confirms that-with the exception of 5Y bonds no 2-year, 5-year and 10-year bonds with less than 0.07, 0.41 and 0.67 years of age were loaned out by the BoC.…”

The assets’ pledgeability channel of unconventional monetary policy

“…However, most of the analyses focus on the direct effect on the interbank market only. Corradin and Maddaloni (2020) show that the outright purchases of assets made by the European Central Bank affect special repo rates, but differently from us they do not provide evidence that scarcity in collateral has also an effect on their prices 7 . D’Amico et al.…”

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

“…Other studies highlight the side effects of central bank asset purchase programs on repo markets. Asset purchases increase scarcity in the repo market, measured by the specialness premium, and also increase delivery failures, as shown by D'Amico, Fan and Kitsul (2018), Arrata et al (2020), and Corradin and Maddaloni (2020). Moreover, QE-induced collateral scarcity feeds back into treasury markets by increasing limits to arbitrage (Pelizzon, Subrahmanyam and Tomio, 2022).…”