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What's behind the liquidity spread? On-the-run and off-the-run US Treasuries in autumn 1998

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  • Craig H Furfine
  • Eli M Remolona

Abstract

Autumn 1998 witnessed the Russian sovereign default and the near collapse of the hedge fund Long-Term Capital Management. These two events were part of a generalised flight to liquidity that affected markets worldwide. In an indepth analysis of the unique market events of that time, the Johnson Report identified ways in which market strains were exacerbated during the period.2 In particular, various yield spreads widened, including spreads between off-therun and on-the-run Treasuries. Although movements in the so-called liquidity spread have attracted much attention as a way to track shifts in market liquidity, there has been little careful analysis of the trading activity that lay behind the dramatic movements of 1998. In this special feature, we find that trading activity in off-the-run Treasuries actually increased during autumn 1998, a fact that would appear to contradict the evidence derived from liquidity spreads, which seemed to indicate reduced liquidity for these securities. We then examine trading activity more closely by focusing on only the most recently off-the-run security and by accounting for anticipated factors that affect trading, including the auction cycle, announcement events and days of the week. Once these factors are isolated, we do find evidence that there was a marked shift in trading away from the offthe- run issue. We then examine the impact of trades on price movements in both the on-the-run and first off-the-run five-year note. We find that the impact of trades on both securities became stronger during autumn 1998, an indication of reduced liquidity for both securities. The increase in the price impact, however, was more pronounced for the off-the-run note. During this period of stress, the impact of trades on the price of the off-the-run note strengthened tenfold while that on the on-the-run note only doubled.

Suggested Citation

  • Craig H Furfine & Eli M Remolona, 2002. "What's behind the liquidity spread? On-the-run and off-the-run US Treasuries in autumn 1998," BIS Quarterly Review, Bank for International Settlements, June.
  • Handle: RePEc:bis:bisqtr:0206f
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    References listed on IDEAS

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    1. Claudio Borio, 2000. "Market liquidity and stress: selected issues and policy implications," BIS Quarterly Review, Bank for International Settlements, November.
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    Cited by:

    1. Abakah, Emmanuel Joel Aikins & Gil-Alana, Luis A., 2022. "Persistence in US Treasury bonds," Finance Research Letters, Elsevier, vol. 45(C).
    2. Csaba Csávás & Szilárd Erhart, 2005. "Are Hungarian financial markets liquid enough? The theory and practice of FX and government securities market liquidity," MNB Occasional Papers 2005/44, Magyar Nemzeti Bank (Central Bank of Hungary).
    3. Catherine L. Mann & Oren Klachkin, 2011. "U.S. Treasury Auction Yields During Boom, Bust, and Quantitative Easing: Role for Fed and Foreign Purchasers," Working Papers 47, Brandeis University, Department of Economics and International Business School, revised May 2012.
    4. Aryo Sasongko & Cynthia Afriani Utama & Buddi Wibowo & Zaäfri Ananto Husodo, 2019. "Modifying Hybrid Optimisation Algorithms to Construct Spot Term Structure of Interest Rates and Proposing a Standardised Assessment," Computational Economics, Springer;Society for Computational Economics, vol. 54(3), pages 957-1003, October.
    5. Eli Remolona & James Yetman, 2022. "De jure Benchmark Bonds," International Journal of Central Banking, International Journal of Central Banking, vol. 18(3), pages 89-124, September.
    6. Pasquariello, Paolo & Vega, Clara, 2009. "The on-the-run liquidity phenomenon," Journal of Financial Economics, Elsevier, vol. 92(1), pages 1-24, April.
    7. Claudio E. V. Borio, 2004. "Market distress and vanishing liquidity: anatomy and policy options," BIS Working Papers 158, Bank for International Settlements.
    8. Akay, Ozgur (Ozzy) & Cyree, Ken B. & Griffiths, Mark D. & Winters, Drew B., 2012. "What does PIN identify? Evidence from the T-bill market," Journal of Financial Markets, Elsevier, vol. 15(1), pages 29-46.
    9. Catherine L. Mann & Oren Klachkin, 2014. "U.S. Treasury Auction Yields Before and During Quantitative Easing: Market Factors vs.Auction Specific Factors," Working Papers 67, Brandeis University, Department of Economics and International Business School.

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