Trading Costs v. Indicative Liquidity in the Off-the-Run Treasury Market

This paper estimates trading costs in the off-the-run Treasury market using comprehensive transactions data and machine learning techniques. The analysis reveals several key findings that enhance the understanding of the off-the-run Treasury market liquidity. First, the indicative bid-ask spread is shown to be a biased measure of liquidity, even when not considering transaction volume. Specifically, bid-ask spreads systematically overstate trading costs of more seasoned Treasuries, and the liquidity of benchmark, on-the-run securities affects how off-the-run bid-ask spreads map to trading costs. Second, the paper demonstrates that trading costs may scale non-monotonically with transaction volume, which suggests selective, opportunistic liquidity-taking. Additionally, transaction size has greater effect on off-the-run securities' trading costs when benchmark, on-the-run liquidity is lower. Finally, indicative bid-ask spreads may notably overstate trading costs for larger orders of relatively less liquid securities. These findings contribute to our understanding of actual liquidity in the off-the-run Treasury market, while highlighting the limitations of a traditional liquidity measure. By providing a more nuanced view of trading costs, this study contributes valuable insights for supporting financial stability and optimal asset allocation.