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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. Agents enter into an infinite-horizon, steady-state market to establish long or short positions. Both the spot and the asset-lending market operate through search. Short-sellers can endogenously concentrate in one asset because of search externalities and the constraint that they must deliver the asset they borrowed. As a result, that asset enjoys both greater liquidity, measured by search times, and a higher lending fee ("specialness"). Liquidity and specialness translate into price premia that are consistent with no-arbitrage. We derive closed-form solutions for small frictions, and can generate price differentials in line with observed on-the-run premia.

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File URL: http://eprints.lse.ac.uk/459/
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Paper provided by London School of Economics and Political Science, LSE Library in its series LSE Research Online Documents on Economics with number 459.

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Length: 74 pages
Date of creation: 23 Apr 2005
Date of revision:
Handle: RePEc:ehl:lserod:459
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  1. Michael J. Fleming, 2002. "Are larger Treasury issues more liquid? Evidence from bill reopenings," Staff Reports 145, Federal Reserve Bank of New York.
  2. Vayanos, Dimitri & Wang, Tan, 2007. "Search and endogenous concentration of liquidity in asset markets," Journal of Economic Theory, Elsevier, vol. 136(1), pages 66-104, September.
  3. Vayanos, Dimitri, 1998. "Transaction Costs and Asset Prices: A Dynamic Equilibrium Model," Review of Financial Studies, Society for Financial Studies, vol. 11(1), pages 1-58.
  4. Huang, Ming, 2003. "Liquidity shocks and equilibrium liquidity premia," Journal of Economic Theory, Elsevier, vol. 109(1), pages 104-129, March.
  5. Jean-Luc Vila & Dimitri Vayanos, 1999. "Equilibrium interest rate and liquidity premium with transaction costs," Economic Theory, Springer, vol. 13(3), pages 509-539.
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  7. Weill, Pierre-Olivier, 2008. "Liquidity premia in dynamic bargaining markets," Journal of Economic Theory, Elsevier, vol. 140(1), pages 66-96, May.
  8. Duffie, Darrell & Garleanu, Nicolae & Pedersen, Lasse Heje, 2002. "Securities lending, shorting, and pricing," Journal of Financial Economics, Elsevier, vol. 66(2-3), pages 307-339.
  9. Heaton, John & Lucas, Deborah J, 1996. "Evaluating the Effects of Incomplete Markets on Risk Sharing and Asset Pricing," Journal of Political Economy, University of Chicago Press, vol. 104(3), pages 443-87, June.
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  14. Keim, Donald B & Madhaven, Ananth, 1996. "The Upstairs Market for Large-Block Transactions: Analysis and Measurement of Price Effects," Review of Financial Studies, Society for Financial Studies, vol. 9(1), pages 1-36.
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  16. Michael J. Barclay & Terrence Hendershott & Kenneth Kotz, 2006. "Automation versus Intermediation: Evidence from Treasuries Going Off the Run," Journal of Finance, American Finance Association, vol. 61(5), pages 2395-2414, October.
  17. Diamond, Peter A, 1982. "Aggregate Demand Management in Search Equilibrium," Journal of Political Economy, University of Chicago Press, vol. 90(5), pages 881-94, October.
  18. Jordan, Bradford D & Jordan, Susan D, 1997. " Special Repo Rates: An Empirical Analysis," Journal of Finance, American Finance Association, vol. 52(5), pages 2051-72, December.
  19. Burdett, Kenneth & O'hara, Maureen, 1987. "Building blocks : An introduction to block trading," Journal of Banking & Finance, Elsevier, vol. 11(2), pages 193-212, June.
  20. Warga, Arthur, 1992. "Bond Returns, Liquidity, and Missing Data," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 27(04), pages 605-617, December.
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  24. Amihud, Yakov & Mendelson, Haim, 1986. "Asset pricing and the bid-ask spread," Journal of Financial Economics, Elsevier, vol. 17(2), pages 223-249, December.
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