S. Viswanathan
Fuqua School of Business, Duke University, Durham, NC 27708
James J.D. Wang
Fuqua School of Business, Duke University, Durham, NC 27708
Abstract
A three-stage model of the U.S. Treasury securities markets is developed to study the interactions between the primary dealer's when issued trading incentives and their bidding behavior in the Treasury auctions. A key feature of the model is the presence of the settlement costs for dealers at the end of the auction cycle. Concentrating on symmetric, linear strategy equilibrium in demand functions, we show that the presence of when-issued trading changes the revenue comparison obtained in one-shot auction models. In particular, the discriminatory auction is preferred when the mean non-competitive demand is lower, the number of dealers is smaller, and the heterogeneity of initial dealer inventories is higher. We derive implications from our model that generally agree with the existing empirical evidence: (1) The expected stop-out price in Treasury auctions contains a price concession ("markup" in yield terms) relative to the when-issued prices both before and after the auction; (2) This price concession is negatively related to the dealers' ability to unwind their positions and to the number of dealers; (3) The variance of the successive price differentials tends to increase (remain constant) over time for discriminatory (uniform-price) auctions; (4) Results of observed differences in price concessions across auction when-issued prices are not indicative of revenues while markups with respect to post-auction when-issued prices are indicative of revenues across auction formats.