Repo specialness and market liquidity: the impact of monetary policy driven funding conditions on the secondary bond cash market

Abstract

The heterogeneous consequences produced by the joint effect of regulatory changes in the financial sector and the implementation of Balance Sheet Policies by the European Central Bank powerfully shed light on the nexus between funding liquidity and market liquidity in the Treasuries cash market. In fact, the introduction of Basel III and the Public Sector Purchase Program inter alia resulted in further frictions on the repo market, pushing repo rates below the Discount Facility Rate, impairing asset pricing and the price discovery process which a fortiori highlighted the scarcity channel of Unconventional Monetary Policies. In fact, tightening money markets conditions could significantly spill over into the cash market, being discounted in the yield curve, as specialness shall be priced as a convenience yield or dividend accruing to the asset owner since it embeds a lower rate in the repo market. Loosing control on the shortest part of the term structure of interest rates may hinder the pass-through of monetary policy too. The objective of this thesis is to empirically analyse the relation between liquidity in the market for repurchase agreements (i.e. the Special Rate of 1-Day Tenor SC transaction) and liquidity in the secondary bond cash market. In particular, liquidity in the cash market is represented by two liquidity metrics widely employed in the literature: the Bid-Ask spread and the Noise measure of Hu et al, 2013. In turn, the effects of specialness on the yield curve are evaluated accordingly.