Bond Market Intermediation and the Role of Repo

Yesol Huh and Sebastian Infante
Additional contact information
Yesol Huh: https://www.federalreserve.gov/econres/yesol-huh.htm
Sebastian Infante: https://www.federalreserve.gov/econres/sebastian-infante.htm

No 2017-003, Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (U.S.)

Abstract: This paper models the important role that repurchase agreements (repos) play in bond market intermediation. Not only do repos allow dealers to finance their activities, but they also increase dealers' ability to satisfy levered client demands without having to adjust their holdings of risky assets. In effect, the ability to borrow specific assets for delivery allows dealers to source large quantity of assets without taking ownership of them. Larger levered client orders imply larger asset borrowing demands, thus increasing the borrowing cost for the asset (i.e., repo specialness). Dealers pass on the higher intermediation cost to their clients in the form of higher bid-ask spreads. Although this method of intermediation is optimal, the use of repos significantly increases dealers' balance sheets. Limiting one dealer's balance sheet leverage, leaving all else equal, reduces the affected dealer's market making abilities and increases his bid-ask spreads. The equilibrium effect of limiting all dealers' balance sheet leverage on bid-ask spreads is unclear, and depends on the intensity of clients' demand and securities lenders' sensitivity to repo specialness.

Keywords: Market liquidity; Financial services and intermediation; Repo; Specialness; U.S. Treasury market (search for similar items in EconPapers)
JEL-codes: G2 G24 G28 (search for similar items in EconPapers)
Pages: 44 pages
Date: 2017-01
New Economics Papers: this item is included in nep-fmk
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedgfe:2017-03

DOI: 10.17016/FEDS.2017.003

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