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Trading Ahead of Treasury Auctions

Last Updated on 10 February, 2024 by Rejaul Karim

The exploration detailed in “Trading Ahead of Treasury Auctions” encapsulates the development of a model elucidating the gradual pre-auction decline in asset prices, a phenomenon particularly evident in anticipation of significant asset sales such as Treasury auctions.

Rooted in the dynamics of risk-averse investors and their expectations of augmented net supply coupled with imprecise signals, the model illuminates the intricate trade-off confronting investors as they navigate between hedging against noise with long positions and speculative endeavors through short positions.

Consequently, the equilibrium price transcends the anticipated price, with the ebbing noise levels and decreased hedging in the run-up to the sale culminating in a decline in price. This theoretical framework finds empirical validation in the context of Italian Treasury issuances, underscoring its practical relevance.

Notably, the study unveils how interactions between the Treasury and primary dealers explicate a 2.4 basis points yield escalation in this pre-auction period – a testament to the tangible impact of anticipated supply shocks and market making dynamics in the landscape of Treasury auctions.

Abstract Of Paper

I develop a model explaining the gradual price decrease observed ahead of anticipated asset sales, such as Treasury auctions. In the model, risk-averse investors expect an increase in the net supply of a risky asset, about which they have a noisy signal. They face a trade-off between hedging the noise with long positions, and speculating with short positions. As a result of hedging, the equilibrium price is above the expected price. As the sale approaches, the noise decreases due to the arrival of information, investors hedge less, and the price decreases. I illustrate the relevance of the theory in the days preceding Italian Treasury issuances. I find that meetings between the Treasury and primary dealers explain a 2.4 bps yield increase.

Original paper – Download PDF

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Author

Jean-David Sigaux
European Central Bank (ECB)

Conclusion

In conclusion, “Trading Ahead of Treasury Auctions” culminates in the development of a comprehensive model attributing the observed gradual decline in asset prices preceding anticipated sales, notably exemplified in Treasury auctions.

The model, rooted in the risk-averse investor’s anticipation of amplified net supply paired with imperfect market signals, delineates the intricate trade-off between noise hedging through long positions and speculative ventures via short positions.

As a consequence of the prevalent hedging, the equilibrium price surpasses the anticipated level, yet as the sale draws near and noise diminishes with the influx of information, investors partake in reduced hedging, precipitating a decline in price.

The empirical validation of this theory in the context of Italian Treasury issuances, where meetings between the Treasury and primary dealers explicate a noteworthy 2.4 basis points yield increase, signifies the tangible impact and practical pertinence of anticipated supply shocks and market making dynamics in the realm of Treasury auctions.

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FAQ

Q1: What is the main focus of the research paper “Trading Ahead of Treasury Auctions”?

A1: The main focus of the research paper is to develop a model that explains the gradual pre-auction decline in asset prices, a phenomenon observed before significant asset sales, particularly in the context of Treasury auctions.

Q2: What is the theoretical framework of the model presented in the paper?

A2: The theoretical framework of the model revolves around the behavior of risk-averse investors who anticipate an increase in the net supply of a risky asset, based on imperfect and noisy signals. Investors face a trade-off between hedging the noise with long positions and engaging in speculation with short positions. The equilibrium price is influenced by this trade-off, resulting in a price above the expected level due to prevalent hedging.

Q3: How does the model explain the observed decline in asset prices before Treasury auctions?

A3: According to the model, as the auction approaches, noise decreases with the arrival of more information. Investors, facing a trade-off between hedging and speculation, reduce their hedging activities, leading to a decline in the equilibrium price. This decline in price is attributed to decreased noise levels and reduced hedging as the sale event draws near.

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