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A Search-Based Theory of the On-the-Run Phenomenon

  • DIMITRI VAYANOS
  • PIERRE-OLIVIER WEILL

We propose a model in which assets with identical cash flows can trade at different prices. Infinitely lived agents can establish long positions in a search spot market, or short positions by first borrowing an asset in a search repo market. We show that short-sellers can endogenously concentrate in one asset because of search externalities and the constraint that they must deliver the asset they borrowed. That asset enjoys greater liquidity, a higher lending fee ("specialness"), and trades at a premium consistent with no-arbitrage. We derive closed-form solutions for small frictions, and provide a calibration generating realistic on-the-run premia. Copyright (c) 2008 by The American Finance Association.

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Article provided by American Finance Association in its journal The Journal of Finance.

Volume (Year): 63 (2008)
Issue (Month): 3 (06)
Pages: 1361-1398

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Handle: RePEc:bla:jfinan:v:63:y:2008:i:3:p:1361-1398
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