Order Imbalance, Liquidity, and Returns of the U.S. Treasury Market
Chunchi Wu () and
Eden S. H. Yu ()
Additional contact information Chunchi Wu: Department of Finance and Managerial Economics, School of Management, University at Buffalo, 335A Jacobs Management Center, Buffalo, New York 14260, USA
Eden S. H. Yu: Department of Economics & Finance, City University of Hong Kong, 83 Tat Chee Avenue, Kowloon Tong, Kowloon, HKSAR, Hong Kong
Previous studies have documented the informational role of order imbalances in price discovery of the Treasury market. In this paper, we explore the liquidity dimension of order imbalances. Through our research, we find evidence which indicates that order imbalances affect Treasury market liquidity. More importantly, order imbalances have significant effects on Treasury market returns and volatility, consistent with the contention that order imbalances can cause an inventory problem of marketwide concern. Results suggest that a significant portion of the effect of order imbalances on price and quoted spread is associated with the inventory premium that compensates market participants for providing liquidity to uninformed traders. The effects of order imbalances on market liquidity, returns and volatility are stronger for two- and five-year notes and Treasury bills. Furthermore, there is commonality in order imbalances. Sensitivity of order imbalances individual bonds to marketwide order imbalances varies across securities.