“Bid Shading and Bidder Surplus in the U.S. Treasury

Auction System” by Horta ̧csu, Kastl and Zhang

Discussion by Paulo Somaini

MIT,NBER

December 2014

Somaini (MIT,NBER) Treasury Auctions December 2014 1 / 12
Introduction

U.S. Treasury auctions bills and notes using an Uniform price format

Somaini (MIT,NBER) Treasury Auctions December 2014 2 / 12
Introduction

U.S. Treasury auctions bills and notes using an Uniform price format

Primary Dealers are large buyers who also route bids of other

participants (indirect bidders)

Somaini (MIT,NBER) Treasury Auctions December 2014 2 / 12
Introduction

U.S. Treasury auctions bills and notes using an Uniform price format

Primary Dealers are large buyers who also route bids of other

participants (indirect bidders)

Can they take advantage of this position? Can we measure their

rents/surplus?

Somaini (MIT,NBER) Treasury Auctions December 2014 2 / 12
Introduction

U.S. Treasury auctions bills and notes using an Uniform price format

Primary Dealers are large buyers who also route bids of other

participants (indirect bidders)

Can they take advantage of this position? Can we measure their

rents/surplus?

State-of-the-art methods to disentangle willingness-to-pay and bid

shading from observed bids

Somaini (MIT,NBER) Treasury Auctions December 2014 2 / 12
Introduction

U.S. Treasury auctions bills and notes using an Uniform price format

Primary Dealers are large buyers who also route bids of other

participants (indirect bidders)

Can they take advantage of this position? Can we measure their

rents/surplus?

State-of-the-art methods to disentangle willingness-to-pay and bid

shading from observed bids

Answer: Primary Dealers surplus is 2.3 bp of issuance ($6.3 bn of $27

trillion). Total bidder surplus is 3 bp

Somaini (MIT,NBER) Treasury Auctions December 2014 2 / 12
Introduction

U.S. Treasury auctions bills and notes using an Uniform price format

Primary Dealers are large buyers who also route bids of other

participants (indirect bidders)

Can they take advantage of this position? Can we measure their

rents/surplus?

State-of-the-art methods to disentangle willingness-to-pay and bid

shading from observed bids

Answer: Primary Dealers surplus is 2.3 bp of issuance ($6.3 bn of $27

trillion). Total bidder surplus is 3 bp

Surplus is an upper bound of potential savings to tax-payers

Somaini (MIT,NBER) Treasury Auctions December 2014 2 / 12
Outline

1 Data: some interesting and motivating facts

2 Economics: PD may be able to take advantage of their position

3 Data & Economics: how to detect the ability to exercise market

power

4 Results in the paper

5 Results in future versions of the paper?

Somaini (MIT,NBER) Treasury Auctions December 2014 3 / 12
Data: Motivating facts

On average, Primary Dealers bid higher yields and larger quantities

than Direct and Indirect bidders

Difference in yields: 3 bp for short-term bills, up to 13 bp for ten-year

notes

Difference in bid-quantities: average PD bids for 10-20 % of issuance

(other bidders 1-5%)

Naturally, PD win a smaller proportion of their tendered quantity

Somaini (MIT,NBER) Treasury Auctions December 2014 4 / 12
Data: Motivating facts

On average, Primary Dealers bid higher yields and larger quantities

than Direct and Indirect bidders

Difference in yields: 3 bp for short-term bills, up to 13 bp for ten-year

notes

Difference in bid-quantities: average PD bids for 10-20 % of issuance

(other bidders 1-5%)

Naturally, PD win a smaller proportion of their tendered quantity

Possible explanations:

PD have systematically lower willingness-to-pay

PD have more elastic demand: they may be willing to buy large

quantities at high yields (low prices)

PD exercise market power

Somaini (MIT,NBER) Treasury Auctions December 2014 4 / 12
Economics: Ability to Exercise Market Power

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Somaini (MIT,NBER) Treasury Auctions December 2014 5 / 12
Economics: Ability to Exercise Market Power

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Somaini (MIT,NBER) Treasury Auctions December 2014 6 / 12
Economics: Ability to Exercise Market Power

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Somaini (MIT,NBER) Treasury Auctions December 2014 7 / 12
Economics: Ability to Exercise Market Power

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Somaini (MIT,NBER) Treasury Auctions December 2014 8 / 12
Data & Economics: Detecting market power

Key insight: ability to exercise market power depends on the (semi)

elasticity of the residual supply curve which can be estimated from

the data

Somaini (MIT,NBER) Treasury Auctions December 2014 9 / 12
Data & Economics: Detecting market power

Key insight: ability to exercise market power depends on the (semi)

elasticity of the residual supply curve which can be estimated from

the data

Bids = Willingness to Pay - Bid Shading

Somaini (MIT,NBER) Treasury Auctions December 2014 9 / 12
Data & Economics: Detecting market power

Key insight: ability to exercise market power depends on the (semi)

elasticity of the residual supply curve which can be estimated from

the data

Bids = Willingness to Pay - Bid Shading

Optimal Bid Shading ≈ Quantity × Slope Residual Supply

Somaini (MIT,NBER) Treasury Auctions December 2014 9 / 12
Data & Economics: Detecting market power

Key insight: ability to exercise market power depends on the (semi)

elasticity of the residual supply curve which can be estimated from

the data

Bids = Willingness to Pay - Bid Shading

Optimal Bid Shading ≈ Quantity × Slope Residual Supply

If bidders are optimizing, their willingness-to-pay can be recovered

from the residual supply and observed price and quantity pair

Somaini (MIT,NBER) Treasury Auctions December 2014 9 / 12
Results

Primary Dealers shade their bids 1.4-3 bp more than Direct and

Indirect bidders

Somaini (MIT,NBER) Treasury Auctions December 2014 10 / 12
Results

Primary Dealers shade their bids 1.4-3 bp more than Direct and

Indirect bidders

They bid lower, but they have 0.5 bp higher willingness-to-pay

Somaini (MIT,NBER) Treasury Auctions December 2014 10 / 12
Results

Primary Dealers shade their bids 1.4-3 bp more than Direct and

Indirect bidders

They bid lower, but they have 0.5 bp higher willingness-to-pay

PD surplus is 2.3 bp of issuance ($6.3 bn of $27 trillion). Total bidder

surplus is 3 bp ($8.1 bn)

Somaini (MIT,NBER) Treasury Auctions December 2014 10 / 12
Results

Primary Dealers shade their bids 1.4-3 bp more than Direct and

Indirect bidders

They bid lower, but they have 0.5 bp higher willingness-to-pay

PD surplus is 2.3 bp of issuance ($6.3 bn of $27 trillion). Total bidder

surplus is 3 bp ($8.1 bn)

Surplus is an upper bound of potential savings to tax-payers: higher

valuations for infra-marginal units, information rents, exercise of

market power

Somaini (MIT,NBER) Treasury Auctions December 2014 10 / 12
Results in future versions of the paper?

Decompose bidders’ surplus in its three components:

Valuation of infra-marginal units

Exercise of Market Power

Rents due to information on Indirect Bidders’ orders

Somaini (MIT,NBER) Treasury Auctions December 2014 11 / 12
Results in future versions of the paper?

Decompose bidders’ surplus in its three components:

Valuation of infra-marginal units

Exercise of Market Power

Rents due to information on Indirect Bidders’ orders

Obtain potential savings to tax-payers under different scenarios

Indirect Bidders’ orders are routed blindly.

No market power

Risk-free interest rate: high frequency indicator of the

willingness-to-lend

Somaini (MIT,NBER) Treasury Auctions December 2014 11 / 12
Results in future versions of the paper?

Decompose bidders’ surplus in its three components:

Valuation of infra-marginal units

Exercise of Market Power

Rents due to information on Indirect Bidders’ orders

Obtain potential savings to tax-payers under different scenarios

Indirect Bidders’ orders are routed blindly.

No market power

Risk-free interest rate: high frequency indicator of the

willingness-to-lend

Value of the information: PD benefit from knowing their customers

bids (Horta ̧csu and Kastl, 2012)

Information about the residual supply (competition)

Information about the value in the secondary market (fundamentals)

Somaini (MIT,NBER) Treasury Auctions December 2014 11 / 12
Conclusion

Excessive market power could be costly

Somaini (MIT,NBER) Treasury Auctions December 2014 12 / 12
Conclusion

Excessive market power could be costly

Billion of tax-payers’ dollars at stake

Somaini (MIT,NBER) Treasury Auctions December 2014 12 / 12
Conclusion

Excessive market power could be costly

Billion of tax-payers’ dollars at stake

State-of-the-art methodology to monitor participants’ ability to

exercise market power

Somaini (MIT,NBER) Treasury Auctions December 2014 12 / 12
Conclusion

Excessive market power could be costly

Billion of tax-payers’ dollars at stake

State-of-the-art methodology to monitor participants’ ability to

exercise market power

Exciting to see data from the U.S treasury

Somaini (MIT,NBER) Treasury Auctions December 2014 12 / 12
Conclusion

Excessive market power could be costly

Billion of tax-payers’ dollars at stake

State-of-the-art methodology to monitor participants’ ability to

exercise market power

Exciting to see data from the U.S treasury

Looking forward to reading future versions of this paper

Somaini (MIT,NBER) Treasury Auctions December 2014 12 / 12
Conclusion

Excessive market power could be costly

Billion of tax-payers’ dollars at stake

State-of-the-art methodology to monitor participants’ ability to

exercise market power

Exciting to see data from the U.S treasury

Looking forward to reading future versions of this paper

Hope collaboration will bring about further developments: new

economic questions, new methods

Somaini (MIT,NBER) Treasury Auctions December 2014 12 / 12