Anticipated and Repeated Shocks in Liquid Markets

We show that Treasury security prices in the secondary market decrease significantly before subsequent auctions and recover shortly after. This price pattern implies a large issuance cost for the Treasury Department, which is estimated to be between 9 and 18 basis points of the auction size. For example, this cost amounts to over half a billion dollars for issuing Treasury notes alone in 2007. Our results appear to be consistent with the hypothesis of primary dealers’ limited risk-bearing capacity and the imperfect capital mobility of end investors in the Treasury market (e.g., federal agencies, sovereign wealth funds, pension funds, and etc.), highlighting the important role of capital mobility even in the most liquid financial markets.