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Rcpo rates are the rates at which bonds and notes can be financed on a collateralized basis. Most Treasury issues trade at the general collateral repo rate, but a few trade at "special" repo rates, which are below the general collateral repo rate. The owner of a security that is on special can obtain financing at an advantageous rate by using that security as collateral in a repurchase agreement. DufEe [1996], Keane [1995], and Sundaresan [1994] provide a detailed description of the repo market.
My research investigates the determinants of relative repo specialness between the most recently issued U.S. Treasury security (the onthe-run) and its immediate predecessor (the old). There are several reasons for investors as well as traders to care about relative specialness. Relative specialness varies considerably across pairs of issues and over time and is a key component of the relative value between bonds. Krishnamurthy [2002] shows that repo specialness severely limits the profitability of trades designed to capture the systematic convergence of the on-the-run to old bond yield spread over each auction cycle. Relative specialness may also signal the market s perception of relative liquidity. DufEe [1996] shows that in general more liquid bonds should trade more special, that is, at lower repo rates.
Most empirical work to date on repo specialness has focused on overnight repo rates and how overnight specialness is related to auction success (Sundaresan [1994]); auction cycles (Keane [1995]); and bond prices in the cash market (Jordan and Jordan |1997|). Longstaff 120001 shows that term general collateral repo rates arc nearly unbiased estimates of overnight general collateral rates, but Buraschi and Menini [2002] find that term special rep ? rates are generally not unbiased estimators of future overnight repo speciahiess.
1 focus on term repo speciahiess for two reasons. First, term repo can be used to lock in a forward price to the next auction date, when an on-the-run issue becomes old and thus would be expected to lose its liquidity advantage. second, an examination of how term specialness varies suggests some reasons that special repo rates often violate the expectations hypothesis.
Many intriguing results emerge from this analysis. I find that the relative specialness of the on-the-run increases as the next auction approaches, indicating that pre-auction...