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Report
How do treasury dealers manage their positions?
Using thirty-one years of data (1990–2020) on U.S. Treasury dealer positions, we find that Treasury issuance is the main driver of dealers’ weekly inventory changes. Such inventory fluctuations are only partially offset in adjacent weeks and not significantly hedged with futures. Dealers are compensated for inventory risk by means of subsequent price appreciation of their holdings. Amid increased balance sheet costs attributable to post-crisis regulatory changes, dealers significantly reduce their position taking and lay off inventory faster. Moreover, the increased participation of ...
Discussion Paper
Credit Market Choice
Credit default swaps (CDS) are frequently credited with being the cause of AIG’s collapse during the financial crisis. A Reuters article from September 2008, for example, notes “[w]hen you hear that the collapse of AIG […] might lead to a systemic collapse of the global financial system, the feared culprit is, largely, that once-obscure […] instrument known as a credit default swap.” Yet, despite the prominent role that CDS played during the financial crisis, little is known about how individual financial institutions utilize CDS contracts on individual companies. In a recent New ...
Working Paper
Hedging and Pricing in Imperfect Markets under Non-Convexity
This paper proposes a robust approach to hedging and pricing in the presence of market imperfections such as market incompleteness and frictions. The generality of this framework allows us to conduct an in-depth theoretical analysis of hedging strategies for a wide family of risk measures and pricing rules, which are possibly non-convex. The practical implications of our proposed theoretical approach are illustrated with an application on hedging economic risk.
Report
Credit market choice
Which markets do institutions use to change exposure to credit risk? Using a unique data set of transactions in corporate bonds and credit default swaps (CDS) by large financial institutions, we show that simultaneous transactions in both markets are rare, with an average institution having an 11 percent probability of transacting in both the CDS and bond markets in the same entity in an average week. When institutions do transact in both markets simultaneously, they increase their speculative positions in CDS by 13 cents per dollar of bond transactions, and their hedging positions by 13 ...
Discussion Paper
The Impact of Trade Reporting on the Interest Rate Derivatives Market
In recent years, regulators in the United States and abroad have begun to strengthen regulations governing over-the-counter (OTC) derivatives trading, driven by concerns over the decentralized and opaque nature of current trading practices. For example, the Dodd-Frank Act will require U.S.-based market participants to publicly report details of their interest rate derivatives (IRD) trades shortly after those transactions have been executed. Based on an analysis of new and detailed data on the trading activity of major dealers, this post discusses the possible costs and benefits of reporting ...