Research

We study optimal securitization in the agency mortgage-backed securities (MBS) market. Many MBS are traded in the liquid to-be-announced (TBA) market, which however induces adverse selection due to cheapest-to-deliver pricing. We find that lenders pool high-value loans separately and trade them in a less liquid market. We estimate a model of MBS pooling and trading to study welfare implications of pooling policies. TBA market structure produces a trade-off between efficiency and equity; broader pooling increases liquidity and average welfare, but results in a larger cross-subsidy from smaller loans to larger loans. Minimizing costs or limiting strategic pooling results in a more regressive redistribution. 

Published Paper

Full Paper 

Internet Appendix

The convention when calculating corporate bond trading costs is to estimate bid-ask spreads that customers pay, implicitly assuming that dealers always provide liquidity to customers. We show that, contrary to this assumption, customers increasingly provide liquidity following the adoption of post-2008 banking regulations and, thus, conventional bid-ask spread measures underestimate the cost of dealers' liquidity provision. Among large trades wherein dealers use inventory capacity, customers pay 40 to 60 percent wider spreads than before the crisis. Customers' balance-sheet capacity and their trading relationships with dealers are important determinants of customer liquidity provision.

Published Paper

Full Paper

Online Appendix

By allowing different agency mortgage-backed securities (MBS) to be traded based on limited characteristics, the to-be-announced (TBA) market generates liquidity and benefits the MBS market broadly. We quantify effects of the TBA structure on mortgage borrowers. Exploiting discontinuities in TBA eligibility, we estimate that TBA eligibility reduces mortgage rates by 7 to 28 basis points. The TBA eligibility benefit is larger for mortgages with higher expected prepayments. We also find that TBA eligibility affects refinancing, which has implications for monetary policy transmission. Our finding is relevant for housing policies, such as housing finance reforms and uniform MBS. 

Published Paper

Full Paper

Internet Appendix

We model the role that repurchase agreements (repos) play in bond market intermediation. Not only do repos allow dealers to finance their activities, but they also enable dealers to source assets without taking ownership. When the asset trades with repo specialness, i.e, when the associated repo rate is significantly below prevailing market rates, borrowing the asset is more expensive, resulting in higher bid-ask spreads. Limiting a single dealer's leverage decreases its market-making abilities, so the dealer charges a higher bid-ask spread. However, limiting all dealers' leverage reduces pressure on repo specialness, thus decreasing bid-ask spreads. More generally, this paper characterizes the importance of collateralized borrowing and lending for bond market intermediation, shows how frictions in repo markets can affect the underlying cash market liquidity, and underscores the importance of securities lending.

Published Paper

Full Paper

In over-the-counter (OTC) securities markets, interdealer markets are an important venue through which dealers can offload positions and share risk amongst themselves. Contrary to the popular conception that search frictions matter the most, we find that in the interdealer market for U.S. corporate bonds, information frictions are most relevant. Large dealers face large and informed customers and pay more than small dealers to transact in the interdealer market, despite on average providing liquidity to other dealers. Large dealers tend to trade through interdealer brokers (IDBs) to mitigate information leakage, but interdealer markets are still far from efficient.

Paper

Paper link

High frequency traders (HFTs) have emerged as important players in financial markets. In today's markets where HFTs act as both liquidity providers and takers, I argue that information asymmetry associated with HFTs' use of public, machine-readable information is important. This particular type of information asymmetry arises because some machines may access the information before other machines. Applying a novel statistical approach to measure HFT activity through limit order book data and using a natural experiment of index inclusion, I show that liquidity-providing HFTs supply less liquidity to stocks that suffer more acutely from this information asymmetry problem. My results also show that stocks with low spreads, high beta, and low volatility have a greater information asymmetry of this type. Moreover, when markets become volatile, this information asymmetry problem becomes more severe, and liquidity provision by HFTs decreases. I discuss implications for market-making activity in times of market stress and for HFT regulations.

Full Paper

Online Appendix

Although previous research has documented a low intraday liquidity commonality across stocks, it has grown over the past decade. Using the introduction of hybrid market in the New York Stock Exchange, I show that at least a part of this growth can be attributed to an increase in algorithmic trading; hybridization increases the 5-minute liquidity comovement by 30 to 50%. Moreover, the effect is stronger at daily frequencies: hybridization induces a 90% higher daily liquidity comovement. These results are due to both an increase in market liquidity risk and a decrease in idiosyncratic liquidity volatility.

Full Paper