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Government Intervention and Strategic Trading in the U.S. Treasury Market

Published online by Cambridge University Press:  18 December 2018

Paolo Pasquariello ,
Jennifer Roush  and
Clara Vega
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Abstract

We study the impact of permanent open market operations (POMOs) by the Federal Reserve on U.S. Treasury market liquidity. Using a parsimonious model of speculative trading, we conjecture that i) this form of government intervention improves market liquidity, contrary to conclusions drawn by existing literature; and ii) the extent of this improvement depends on the market’s information environment. Evidence from a novel sample of Federal Reserve POMOs during the 2000s indicates that bid–ask spreads of on-the-run Treasury securities decline when POMOs are executed, by an amount increasing in proxies for information heterogeneity among speculators, fundamental volatility, and POMO policy uncertainty, consistent with our model.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 55 , Issue 1 , February 2020 , pp. 117 - 157
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2018 

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Footnotes

1

We thank Michael Gulick for outstanding research assistance, and an anonymous referee, Gara Afonso, Hendrik Bessembinder (the editor), Sugato Bhattacharyya, Tarun Chordia, Robert Engle, Andreas Fischer, Michael Fleming, Thierry Foucault, Larry Harris, Kentaro Iwatsubo, Collin Jones, Andrew Karolyi, Marc Lipson, Anna Obizhaeva, Maureen O’Hara, Amiyatosh Purnanandam, Marti Subrahmanyam, Rufei Zhu, and seminar participants at the Banque de France, University of Warwick, Swiss National Bank, University College London, the 2011 EFA meetings, the 2011 NBER Market Microstructure meetings, the 2014 AFA meetings, Washington State University, and the 2014 International Conference on Sovereign Bond Markets for comments. The views in this article are solely the responsibility of the authors and should not be interpreted as reflecting the views of the Board of Governors of the Federal Reserve System or of any other person associated with the Federal Reserve System. All errors are ours.

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