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A Model of the Convenience Yields in On-the-Run Treasuries

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  • Joseph A. Cherian
  • Eric Jacquier
  • Robert A. Jarrow

Abstract

The convenience yield differential between on- and off-the-run Treasury securities with identical maturities has two components. A non-cyclical component may arise due to the higher illiquidity of off-the-run bonds. Also, trading in the market for the next issue often causes cyclical shortages of the on-the-runs. When this occurs, owners of the on-the-run bond can earn riskless profits by borrowing at a special repo rate while lending at the prevailing risk free market rate. This second component of the convenience yield, induced by the auction, is cyclical. We first show that special repo rates and the convenience yield are jointly cyclical over the auction cycle. The patterns are statistically significant and pervasive. Repo specials are highest around the announcement day and disappear by the issue day. The off- minus on-the-run yield spread is highest at the beginning of the cycle and collapses near its end, consistent with a decreasing present value of profits over a decreasing horizon. Second, we develop a first no-arbitrage continuous-time model, with both interest and special repo rates stochastic, that prices the on-the-run bonds that command this convenience yield. A simple implementation of the model can generate yields consistent with the evidence.

Suggested Citation

  • Joseph A. Cherian & Eric Jacquier & Robert A. Jarrow, 2004. "A Model of the Convenience Yields in On-the-Run Treasuries," Review of Derivatives Research, Springer, vol. 7(2), pages 79-97, August.
  • Handle: RePEc:kap:revdev:v:7:y:2004:i:2:p:79-97
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    Citations

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    Cited by:

    1. Stefania D'Amico & Roger Fan & Yuriy Kitsul, 2013. "The Scarcity Value of Treasury Collateral: Repo Market Effects of Security-Specific Supply and Demand Factors," Working Paper Series WP-2013-22, Federal Reserve Bank of Chicago.
    2. Michael J. Fleming & Kenneth D. Garbade, 2005. "Explaining settlement fails," Current Issues in Economics and Finance, Federal Reserve Bank of New York, vol. 11(Sep).
    3. Fleming, Michael J. & Garbade, Kenneth D., 2007. "Dealer behavior in the specials market for US Treasury securities," Journal of Financial Intermediation, Elsevier, vol. 16(2), pages 204-228, April.
    4. Graveline, Jeremy J. & McBrady, Matthew R., 2011. "Who makes on-the-run Treasuries special?," Journal of Financial Intermediation, Elsevier, vol. 20(4), pages 620-632, October.
    5. Marcello Pericoli & Marco Taboga, 2015. "Decomposing euro area sovereign spreads: credit, liquidity and convenience," Temi di discussione (Economic working papers) 1021, Bank of Italy, Economic Research and International Relations Area.
    6. David Goldreich & Bernd Hanke & Purnendu Nath, 2005. "The Price of Future Liquidity: Time-Varying Liquidity in the U.S. Treasury Market," Review of Finance, Springer, vol. 9(1), pages 1-32, March.
    7. Díaz, Antonio & Escribano, Ana, 2017. "Liquidity measures throughout the lifetime of the U.S. Treasury bond," Journal of Financial Markets, Elsevier, vol. 33(C), pages 42-74.
    8. Feldhütter, Peter & Lando, David, 2008. "Decomposing swap spreads," Journal of Financial Economics, Elsevier, vol. 88(2), pages 375-405, May.
    9. Antonio Díaz & Francisco Jareño & Eliseo Navarro, 2020. "Yield curves from different bond data sets," Review of Derivatives Research, Springer, vol. 23(2), pages 191-226, July.
    10. Díaz, Antonio & Jareño, Francisco & Navarro, Eliseo, 2018. "Zero-coupon interest rates: Evaluating three alternative datasets," Economics Discussion Papers 2018-67, Kiel Institute for the World Economy (IfW Kiel).
    11. Kenneth D. Garbade & Matthew Rutherford, 2007. "Buybacks in Treasury cash and debt management," Staff Reports 304, Federal Reserve Bank of New York.

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