Bond supply, price drifts and liquidity provision before central bank announcements

Dong Lou (), Gabor Pinter and Semih Üslü
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Dong Lou: London School of Economics

No 998, Bank of England working papers from Bank of England

Abstract: We document that UK government bond yields systematically rise in a two-day window before Monetary Policy Committee (MPC) meetings, which we refer to as pre-MPC windows. The effect concentrates on pre-MPC windows that coincide with new issuance of government bonds. Decomposing the effect into an expected short-rate and a risk premium component, we find that the majority of the yield drift is attributed to increases in risk premia. These effects are present in the US as well. Using UK transaction-level data and analysing trading activity after primary issuances, we find that the dealer sector sells significantly more to the client sector during pre-MPC windows, consistent with dealers’ limited risk-bearing capacity. Importantly, we find significant changes in the composition of liquidity providers: hedge funds buy a large share of the issue outside pre-MPC windows, but they shy away from liquidity provision in pre-MPC windows, being replaced by less speculative investors such as foreign government entities and pension funds. We propose a theoretical model to rationalise the change in the composition of liquidity providers before high-informational events, which can also explain the price drift observed in the data.

Keywords: monetary policy announcements; price drift; bond supply (search for similar items in EconPapers)
JEL-codes: E52 E63 G10 G20 (search for similar items in EconPapers)
Pages: 57 pages
Date: 2022-10-21
New Economics Papers: this item is included in nep-cba, nep-fmk and nep-mon
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:boe:boeewp:0998

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