Anticipated and Repeated Shocks 

in Liquid Markets

Dong Lou, LSE

Hongjun Yan, Yale 

Jinfan Zhang, Yale
Motivation

 How does a financial system absorb supply shocks?

 when capital mobility is imperfect

 Anticipated

 Repeated 

 Liquid markets

 US Treasury auctions

 Treasury market

 Repo market

 Stock market

Hongjun Yan 2
Main Results

Hongjun Yan 3
Why is this a big deal?

 Treasury appears to sell at low prices

 Large issuance cost e.g., 5 days

 2-year note 9 basis points

 5-year note 17 basis points

 10-year note 18 basis points

 E.g., for 2007, $649 million

Hongjun Yan 4
Trading profit

 Short 2-y note before each auction 

 Long it after each auction

 Duration hedge

 Sharpe ratio in the full sample: 1.08

 In the last 10 years: 1.44

 After bid-ask spread: 0.95

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Hongjun Yan
Implication for theory

 Large price pressure in the secondary market 

 ∆CR(5) = 9 b.p. ∆CR(5) = 49 b.p.

 2-year note stock market

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Hongjun Yan
Interpretation 

7

Bond 

Treasury

Repo

Stock

Federal govmt 

Account

Federal 

Reserve

State local govmt

Foreign investors

Mutual funds, Banks

Insurance companies

Hongjun Yan

Primary Dealer Primary Dealer ...... Primary Dealer
Summary

 Capital immobility is of first-order importance. 

 Even liquid markets are slow in absorbing 

anticipated shocks, which are relatively small

 Trading profit

 Large issuance cost

 Interpretation 

 Limited risk bearing capacity

 The immobility of End Investors’ capital

 Guidance for finance theory, auction design

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Policy Proposal 

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 A A

 A A A A
Policy Proposal (cont’d)

 Treasury

 Benefit: lower issuance costs

 Cost: “no known side-effects”

 Dealers

 Benefit: smaller amount of capital

 Cost: more complex planning?

 Hedge funds

Hongjun Yan 10
Data

 Treasury Note Auctions (2- 3- 4- 5- 7- 10-year) 

 US Treasury Department , 1980-2008

 Bond and Stock data

 CRSP, COMPUSTAT

 Implied Interest Rate Volatility

 Bond option prices from CBOE

 Repo Rates

 Bloomberg

 Insurance company trading

 NAIC

 Fund flow data

 Trimtabs

Hongjun Yan 11
Treasury Auctions

 Treasury markets 3 trillion issuance per year

 Dates: scheduled months in advance

 Amounts: announced several days in advance

 We focus on Notes: 2, 5, 10-year

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Treasury Returns Around Auctions

Hongjun Yan 13

Panel A: On-the-run Treasury note returns around subsequent auctions: ∆CR(t)

Days around 2-year notes 5-year notes 10-year notes

auctions Mean t-Value Mean t-Value Mean t-Value

1 3.68*** (3.90) 1.98 (0.99) 8.61 (1.53)

2 3.54** (2.21) 9.94*** (4.03) 10.87 (1.13)

3 6.15** (2.42) 16.86*** (4.28) 26.37** (2.31)

4 8.66*** (2.87) 20.86*** (4.34) 31.61*** (2.75)

5 8.89*** (2.69) 22.54*** (3.67) 23.84* (1.78)

6 10.20*** (3.62) 17.12** (2.07) 16.44 (1.31)

7 9.42*** (2.63) 21.21** (2.20) 17.44 (1.01)

8 9.61** (2.28) 27.59*** (3.01) 30.4* (1.67)

9 9.08** (2.23) 22.85** (2.43) 40.68** (2.02)

10 9.20** (2.02) 22.77** (2.53) 32.45 (1.39)

No. Obs. 332 210 132
Cost of Issuance

Hongjun Yan 14

Panel B: Costs of issuance based on the average yield on days -t and t

2-year notes 5-year notes 10-year notes All notes

t Percentage 

(basis points)

Amount 

(Millions)

Percentage 

(basis points)

Amount

(Millions)

Percentage 

(basis points)

Amount

(Millions)

Amount

(Millions)

1 6.72 172 6.57 103 9.42 79 354

2 7.22 185 10.48 164 10.53 88 437

3 8.33 213 14.23 222 19.68 165 600

4 8.95 229 16.06 251 22.11 186 665

5 9.07 232 16.81 262 18.43 155 649

6 9.86 252 14.31 223 15.32 129 604

7 10.03 257 16.43 256 16.84 141 654

8 9.95 255 19.51 304 24.88 209 768

9 9.31 238 16.89 263 30.42 256 757

10 9.34 239 16.85 263 26.68 224 726
Trading Profit

Hongjun Yan 15

Panel A: Hedge portfolio returns Panel B: Hedge portfolio returns 

in the full sample (1980-2008) in the period of 1998-2008

t Mean t-value Sharpe Ratio t Mean t-value Sharpe Ratio

1 1.04* (1.67) 0.34 1 -0.40 (-0.47) -0.14

2 2.40*** (2.89) 0.66 2 1.37 (1.60) 0.50

3 4.41*** (3.35) 0.94 3 2.61*** (2.68) 0.84

4 4.96*** (3.30) 0.98 4 4.15*** (4.01) 1.05

5 5.87*** (3.10) 0.95 5 4.78*** (3.48) 1.06

6 6.39*** (3.95) 1.05 6 6.85*** (4.66) 1.32

7 8.17*** (4.00) 1.20 7 8.02*** (5.14) 1.56

8 8.10*** (3.88) 1.12 8 7.62*** (4.64) 1.41

9 8.24*** (3.60) 1.08 9 8.13*** (5.08) 1.44

10 8.62*** (3.65) 1.08 10 8.52*** (4.95) 1.44

No. Obs 319 No. Obs 116
Further Predictions

 Primary dealers’ limited risk-bearing capacity

 Spill over to other maturities

 Auction size 

 Market risk

 The immobility of end-investors’ capital

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Spillover Across Maturities

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10-year Treasury yields around 2- and 5-year note auctions: Y(t) -Y(0)

Days around around 2-year note auctions around 5-year note auctions

auctions Mean t-Value Mean t-Value

-5 -1.48 (-1.50) -2.71** (-2.26)

-4 -1.44 (-1.61) -2.89** (-2.51)

-3 -1.41* (-1.72) -1.57 (-1.60)

-2 -0.96 (-1.63) -0.69 (-1.00)

-1 -1.20*** (-2.70) 0.01 (0.01)

1 -0.74* (-1.93) -0.22 (-0.42)

2 -0.44 (-0.67) -2.12*** (-2.98)

3 0.23 (0.22) -3.08*** (-4.18)

4 -0.68 (-0.60) -2.31*** (-2.90)

5 -0.8 (-0.61) -3.22*** (-3.00)

No. Obs. 275 144
Limited risk-bearing capacity

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Panel A: Dependent Variable = HRet (10)

Coefficient (*10000) t-value

Offering Amount 4.58* (1.71)

Implied Volatility 1.68** (2.28)

Panel B: Dependent Variable = daily 2-year note return

Coefficient (*10000) t-value

Dependent Variable = daily 2-year note return

OSI(5) 0.029*** (2.79)

Dependent Variable = daily 2-year note return

OSI(10) 0.046*** (3.83)
Immobile End-investor

 40% of the $10 Trillion is nonmarketable 

 Fed 9% 

 State, local and foreign governments 

 Insurance companies (70% make <5 trades)

 Bond mutual funds

 Index funds

 Active funds

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Mutual fund-investors

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Mutual fund flows around 2-year Treasury note auctions: ∆FLOW(t)

Days around bond funds equity funds hybrid funds

auctions Mean t-Value Mean t-Value Mean t-Value

1 -0.03%** (-2.22) 0.00% (-0.37) -0.03%*** (-2.60)

2 -0.02% (-1.11) 0.01% (0.52) -0.02% (-1.58)

3 0.03%** (2.03) -0.01% (-0.32) -0.02% (-1.21)

4 0.05%*** (3.01) -0.01% (-0.55) -0.01% (-0.73)

5 0.06%*** (3.06) -0.02% (-0.84) -0.03% (-1.32)

6 0.14%*** (2.82) -0.03% (-1.30) -0.05%* (-1.86)

7 0.15%*** (2.87) -0.03% (-1.05) -0.05%* (-1.81)

8 0.15%*** (2.95) -0.02% (-0.89) -0.05%* (-1.74)

9 0.16%*** (3.15) -0.03% (-1.05) -0.04% (-1.14)

10 0.16%*** (3.02) -0.04% (-1.29) -0.09%** (-2.16)

No. Obs. 120 120 120
Repo Market

Hongjun Yan 21

Average Repo rate around auctions: ∆Repo(t) (basis point)

Days around Overnight One-week One-month

auctions Mean t-Value Mean t-Value Mean t-Value

1 1.38 (0.99) 1.33 (1.50) -0.70* (-1.65)

2 3.69** (2.39) 2.43*** (2.72) 0.11 (0.27)

3 5.09*** (3.29) 3.78*** (3.84) 0.78 (1.62)

4 6.53*** (4.53) 4.47*** (4.31) 1.11* (1.78)

5 6.75*** (4.83) 4.39*** (4.36) 1.41** (2.03)

6 6.50*** (4.67) 3.94*** (3.80) 1.08 (1.30)

7 5.85*** (4.26) 3.41*** (3.22) 0.81 (0.86)

8 4.85*** (3.49) 2.78** (2.28) 0.43 (0.37)

9 4.13*** (2.79) 2.19 (1.59) 0.11 (0.08)

10 3.47** (2.21) 1.68 (1.10) -0.19 (-0.12)

No. Obs. 198 198 198
Implication for theory

 Large price pressure in the secondary market 

 ∆CR(5) = 8.89 b.p. (t=2.69)

 Expected return around auctions

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Hongjun Yan
Stock Returns Around Auctions

 Spillover to the stock market 

 ∆CR(5) = 49 b.p. (t=3.11)

 Expected stock return around auctions

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Hongjun Yan
Robustness

 Off-the-run

 Subsample

 Turn of the month effect

 Where to put the auction day

 Uneven calendar days

 Information revelation around auctions

Hongjun Yan 24
Conclusions

 Anticipated and frequently repeated shocks have 

significant price impacts 

 Treasury market

 Repo market

 Stock market

 Large issuance cost

 Limited risk-bearing capacity, and capital 

immobility

 Implication for Macroeconomics and Finance

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