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Repo Counterparty Risk and On-/Off-the-Run Treasury Spreads

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  • Sheen Liu
  • Chunchi Wu

Abstract

We propose a dynamic asset pricing model in which two assets with identical cash flows can trade at different prices not only because of differences in liquidity but counterparty risk. Counterparty risk reduces lenders or borrowers’ willingness to supply funds and collateral, incentives to shortsell and lend, and the likelihood for new bonds to be on special, thereby narrowing on-/off-the-run spreads and affecting asset prices in spot markets. Consistent with this prediction, we find that on-/off-the-run spreads are low when counterparty risk is high and this relationship is much stronger during the financial crisis.

Suggested Citation

  • Sheen Liu & Chunchi Wu, 2017. "Repo Counterparty Risk and On-/Off-the-Run Treasury Spreads," The Review of Asset Pricing Studies, Society for Financial Studies, vol. 7(1), pages 81-143.
    • Handle: RePEc:oup:rasset:v:7:y:2017:i:1:p:81-143.
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    File URL: http://hdl.handle.net/10.1093/rapstu/raw008
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    Cited by:

    1. Corradin, Stefano & Maddaloni, Angela, 2020. "The importance of being special: Repo markets during the crisis," Journal of Financial Economics, Elsevier, vol. 137(2), pages 392-429.

    More about this item

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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