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

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Abstract

We study price dislocations and liquidity provision by dealers and the Federal Reserve (Fed) as the “dealer of last resort” in agency MBS markets during the COVID-19 crisis. As customers sold MBS to “scramble for cash,” dealers provided liquidity by taking inventory in the cash market and hedging inventory risk in the forward market. The cash and forward prices diverged significantly beyond the difference in the quality of MBS traded on the two markets. The Fed first facilitated dealers’ inventory hedging and then took holdings off dealers’ inventory directly. The price dislocations began to revert only after the Fed’s latter action, when customer selling was still strong.

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  • Jiakai Chen & Haoyang Liu & Asani Sarkar & Zhaogang Song, 2020. "Dealers and the Dealer of Last Resort: Evidence from MBS Markets in the COVID-19 Crisis," Staff Reports 933, Federal Reserve Bank of New York.
  • Handle: RePEc:fip:fednsr:88380
    Note: Revised October 2021. 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; liquiditiy; 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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