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Dealers and the Dealer of Last Resort: Evidence from the Agency MBS Markets in the COVID-19 Crisis

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Abstract

When market disruptions started in March 2020, dealers maintained the usual liquidity provision in the agency MBS market by taking cash inventory and hedging inventory risk with forward contracts. However, cash and forward prices significantly diverged and began to converge only after the Federal Reserve deployed nonstandard purchase operations to promptly take MBS off dealers’ balance sheets. Further cross-dealer analyses point to supplemental leverage ratio requirements as major constraints on dealers’ balance sheets. Customers’ selling increased when price divergence reverted, inconsistent with conjectures of some studies. Comparisons with corporate bond markets uncover additional dealer frictions.

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  • Jiakai Chen & Haoyang Liu & Asani Sarkar & Zhaogang Song, 2020. "Dealers and the Dealer of Last Resort: Evidence from the Agency MBS Markets in the COVID-19 Crisis," Staff Reports 933, Federal Reserve Bank of New York.
    • Handle: RePEc:fip:fednsr:88380
    Note: Revised February 2024. Previous title: “Cash-Forward Arbitrage and Dealer Capital in MBS Markets: COVID-19 and Beyond”
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    More about this item

    Keywords

    arbitrage; cash; dealer; liquidity; MBS; specified pool; TBA; COVID-19;
    All these keywords.

    JEL classification:

    • D8 - Microeconomics - - Information, Knowledge, and Uncertainty
    • G2 - Financial Economics - - Financial Institutions and Services

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