Government Intervention and Strategic Trading in the U.S. Treasury Market

Paolo Pasquariello, Jennifer Roush and Clara Vega

Journal of Financial and Quantitative Analysis, 2020, vol. 55, issue 1, 117-157

Abstract: We study the impact of permanent open market operations (POMOs) by the Federal Reserve on U.S. Treasury market liquidity. Using a parsimonious model of speculative trading, we conjecture that i) this form of government intervention improves market liquidity, contrary to conclusions drawn by existing literature; and ii) the extent of this improvement depends on the market’s information environment. Evidence from a novel sample of Federal Reserve POMOs during the 2000s indicates that bid–ask spreads of on-the-run Treasury securities decline when POMOs are executed, by an amount increasing in proxies for information heterogeneity among speculators, fundamental volatility, and POMO policy uncertainty, consistent with our model.

Date: 2020
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