Pengjie Gao ± , Paul Schultz ± , and Zhaogang Song * ± University of Notre Dame * Federal Reserve Board Annual Central Bank Workshop on Microstructure of Financial Markets, Rome October , 2014 Do the Federal Reserve’s Asset Purchases Harm MBS Market Liquidity? Disclaimer: The analysis and conclusions set forth are those of the authors and do not indicate concurrence by the Board of Governors of the Federal Reserve System. Preliminary and Comments Welcome 1
Transcript
Pengjie Gao±, Paul Schultz±, and Zhaogang Song*
± University of Notre Dame
* Federal Reserve Board
Annual Central Bank Workshop on Microstructure of Financial Markets, Rome
October , 2014
Do the Federal Reserve’s Asset Purchases Harm MBS Market Liquidity?
Disclaimer: The analysis and conclusions set forth are those of the authors and do not indicate concurrence by the Board of Governors of the Federal Reserve System.
Preliminary and Comments Welcome
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QE: Fed’s MBS Purchase in Oct-2011 to Apr-2013
Source: Table 1 2
“One possible cost of conducting additional LSAPs is that these operations could impair the functioning of securities markets. Conceivably, if the Federal Reserve became too dominant a buyer in certain segments of these markets, trading among private agents could dry up, degrading liquidity and price discovery.” (italics added)
- Ben Bernanke Jackson Hole Meetings
August 31, 2012
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What we do in this paper 1. Quantify the impact of Fed’s purchases on MBS
liquidity Harm: reduced tradable supply for private investors Improve: Reduce search frictions (Duffie, Garleanu, and Pedersen 05; Vayanos
and Weill 08…) Reduce adverse selection concerns (Pasquariello, Roush, and Vega
14) The impact is an open question The impact is not clear even more in To-be-announced and Specified pool venues
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What we do in this paper 2. We empirically investigate channels of the Fed’s
purchase impact on over-the-counter MBS liquidity
Information asymmetry Inventory Search frictions
Such results will shed light on fundamental theories of over-the-counter markets
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A Quick Overview of Results Liquidity improvement in both TBA and SP markets TBA segment with Fed purchases: the average trading cost
declines by 0.86 - 0.91 bpts from the non- intervention levels of 1.26 - 1.35 bpts
Corresponding SP segment: the average trading cost decreases by 9.6 - 11.1 bpts from the non-intervention levels of 19.5 - 29.4 bpts
Channels of liquidity improvement TBA segment with Fed purchases: a reduction in both
search frictions and information asymmetry concerns Corresponding SP segment: low costs for inventory
hedging but not reduction in search frictions 6
Literature Impact of unconventional monetary policies on prices Krishnamurthy and Vissing-Jorgensen (2011, 2013) Hancock and Passmore (2011, 2013): MBS yields D’Amico and King (2013): Treasury yields
Microstructure of MBS market Trading cost: Atanasov and Merrick (2013), Bessembinder,
Maxwell and Venkataraman (2013), Friewald, Jankowitsch, and Subrahmanyam (2013), Vickery and Wright (2013)
Network structure: Hollifield, Neklyudov, and Spatt (2013)
Market Structure: two parallel venues To-be-announced (TBA) forward trading Pooling trade: forward contract by agency, loan term, coupon,
price, par amount, settlement date A buyer knows what specific MBS to be delivered only 48-hour
before the settlement date; cheapest-to-deliver Highly liquid: 90% of volume; a cost of 1.2–1.4 bps (our estimate)
Specified pool (SP) trading Buyers know what MBS to get upon transaction: more info TBA ineligible and eligible (better parameters) Less liquid: 10% of volume; a cost of 20–30 bps (our estimate)
Liquidity externality TBA prices serve as a benchmark SP: Atanasov and Merrick (2012) TBAs as hedging tools for SP: Gao, Schultz, and Song (2014)
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The Fed’s MBS Purchases Only “Production-coupon” TBAs: coupon rates close to the concurrent primary mortgage rates
(minus a servicing fee) The largest new issuances
We shall study liquidity of “Production coupon” TBAs “Production coupon” SPs “Non-Production coupon” TBAs and SPs
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Data Market surveillance data compiled by FINRA From May 16, 2011 & for structured products Data releases by FINRA Similar to non-public version of TRACE corporate bond data
MBS purchases at the CUSIP level from FRBNY eMBS database: TBA and SP CUSIP-level security
characteristics Sample period Pre-LSAPs period (May-2011 to Sep-2011): “Reinvestment Program” (Oct-2011 to Jun-2012): $30 billion QE3 (Jul-2012 to Apr-2013) Period: additional $40 billion
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Empirical Method (TBA) Panel regression: both D-C and C-C trades
∆𝑃𝑃𝑖𝑖𝑖𝑖: percentage price change from a previous to current trade ∆𝑄𝑄𝑖𝑖𝑖𝑖 = 𝑄𝑄𝑖𝑖𝑖𝑖 − 𝑄𝑄𝑖𝑖𝑖𝑖−𝜏𝜏,𝑄𝑄𝑖𝑖𝑖𝑖 = 1 customer buy, 𝑄𝑄𝑖𝑖𝑖𝑖 = −1 customer sell 𝛽𝛽0: average round-trip transaction cost prior to the Fed purchase Schultz (2001), Bessembinder, Maxwell, and Venkataraman
(2006, 2013) 𝛽𝛽1: the impact of Fed intervention on transaction costs
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Key identification: controls Staggered intervention Securities that are eventually “treated,” yet currently
“untreated” serve as “controls” for securities that are currently “treated”
We further fine tune the “control” sample A MBS must be in active issuance to be included as “control” This is to ensure we do not simply pick up liquidity difference
between “production” vs. “non-production” rates MBS
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Illustration of Controls
Source: Table 1 16
Result: Liquidity Impact in Production-coupon TBAs (1)
Source: Table 5 17
Result: Liquidity Impact in Production-coupon TBAs (2)
Source: Table 6 18
Liquidity impact: Production-coupon SP (1)
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Channels of Liquidity Improvement
“Production-coupon” TBAs Search friction Information asymmetry concerns
“Production-coupon” SP Reduction of dealer’s inventory hedging costs in SP
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“Production-coupon” TBAs: adverse selection Comparison of prices of Fed purchases versus purchases just before or after. Large trades are $250 million or more
The Fed’s LSAPs transaction prices exhibit strong mean-reversion.
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The Fed’s LSAPs vs. Non-Fed Trades
No evidence that the Fed’s LSAPs provide benchmark prices!
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“Production-coupon” TBAs: search
• Large trade imbalance (in trade numbers as well as in dollar amount) indicates stronger search frictions.
• Trade imbalance decreases after the Fed’s LSAPs – which indicates reduction of search frictions.
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“Production-coupon” SP: inventory No reduction in search frictions Inventory hedging
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Summary The huge Fed purchase of MBS is a fertile ground for
understanding the microstructure of OTC MBS market Liquidity improvement directly and indirectly Channels of liquidity improvement
Implication Policy: the QE programs improve market liquidity rather
than harm it; Terminating the purchases will decrease the market liquidity
OTC structure and trading: importance of search frictions, information asymmetry, and inventory controls when a large player is present
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Liquidity impact: Production-coupon SP (2)
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Liquidity impact: Production-coupon SP (3)
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Empirical Model: non-production coupon MBS The Fed did not purchase any non-production rate MBS How to evaluate the LSAPs impact on non-production rate MBS
liquidity? Without a better alternative, we estimate the following models
