The U.S. Treasury: Types of Markets
and Auctions
Petar Petrov
ECON 1465, Fall 2010
Brown University
What is a Treasury
• U.S. Government debt obligations backed by
its full faith and credit
• Bills (< 1y), Notes (1-5y), Bonds (>5y), TIPS
• Very low risk associated
• Used for funding government projects
• Used for controlling money supply
• Over $2 trillion in securities are issued every
year
Types by issue date
• While issued: when the issue is announced
but the auction is not yet carried out
• On-the-run: the current newest issue of a
particular type of securities
• Off-the-run: when a newer issue of the same
type of securities is auctioned, the old ones
become off-the-run
Markets for Treasuries
• Primary market – Auctions
• Frequency: 4-, 13-, 26-week bills – weekly, 52-week, 2-,
3-, 5- and 7-year notes – monthly, 10- and 30-year
bonds – biannually
• Competitive bidders (18 primary dealers) post a pair of
bid-quantity, representing the quantity they want to
buy at that price, multiple bids possible
• Noncompetitive bidders post a quantity they want to
buy, all of them win at a price which is the quantity
weighted average of the competitive bids
Markets for Treasuries
• Secondary Markets: over the counter and
electronically organized systems by
interdealers
• Federal Bank of NY – biggest trader
• Primary dealers act as market makers,
providing bid-ask quotes, holding inventory
• Biggest market in the world, relatively liquid
Markets for Treasuries
• When-issued Market: a forward market
between the primary dealers and their
institutional investors
• Quantity in the futures: ranging from a small
one to several times the size of the issue
• Starts at the announcement of the auction
and ends and settles at the date of the issue
• Close to the Chicago Board of Trade Treasuries
futures market
Types of Auctions: Discriminatory price
• Competitive bidders place bid-quantity sealed
bids
• Each winning competitive bidder pays the bid
he submitted
• Noncompetitive bidders pay a quantityweighted average of the winning competitive
bids
Types of Auctions: Uniform price
• Competitive bidders place bid-quantity sealed
bids
• Each winning competitive bidder pays the
highest loosing bid
• Noncompetitive bidders pay a quantityweighted average of the winning competitive
bids
Common properties of auctions
• The common value assumption: no matter
how much they pay in the auction, the buyers
face the same value in the secondary market
• Asymmetry of information: each buyer has a
unbiased private value of the uniform
unknown value they are going to face on the
secondary market. The average of all those
values is believed to be close to the actual
value
Problems with the markets: The
purpose of Treasuries and incentives
• The main purpose of the Treasuries is to raise
funds for the U.S. Government in order to
fund its projects and programs, thus revenue
maximization is the main problem
• The seller must set the right incentives and
lower the risk for the buyers as much as
possible in order for them not to underbid
Problems with the markets: The cost
of gathering information
• Proprietary forecasting models or purchasing
information from an outside source are costly
• Forward and futures markets have implied volatility
because of speculators that do not cover their bets
• These costs are offset by underbidding
• The seller should release as much information as
possible about the auctions and securities issued
• The government should facilitate the forward and
futures market, lower the risk involved in participating
in them in order to make the signals more stable,
significant and reliable
Problems with the markets: The cost
of reselling
• Discriminatory auctions favor fewer buyers,
which face bigger losses if they cannot sell
their inventories
• Tending to those transactions has a cost
• The cost must be offset by underbidding
• It is proposed that the seller might save up to
75 basis points if he switches to uniform price
auctions
Problems with the markets: Sending
signals to the secondary market
• Competitive sellers want to clear part of their
inventories and thus if they have a firm belief of a drop
of interest rates and thus a hike in prices, they would
like to signal that
• Assuming investors learn from auction results, a good
way of signaling is through the bids made
• A higher bid, however, costs the bidders more in a
discriminatory auction, so they tend to shed their bids
more
• In contrast, the desire to signal information results in a
more aggressive bidding strategies in the uniform price
auctions, resulting in higher revenues
Problems with the markets: Winner’s
Curse
• The Winner’s Curse is the situation in which
the winning bidders pay more than the shared
average price of the item
• Bidders’ fear of the Winner’s Curse makes
them lower their bids
• Winner’s Curse is directly proportional to
uncertainty
Problems with the markets: Winner’s
Curse
• Seller– disclose honest and complete
information about the auction and
expectation of the secondary-market price
• Uniform price auctions decrease the fear of
the Winner’s Curse since all the bidders pay
the bid of the first looser, which makes them
bid closer to their real expectations of the
secondary-market price an leads to a overall
more aggressive bidding strategies
Problems with the markets:
Noncompetitive bidding and squizes
• Noncompetitive behavior/lack of participants
disturbs the efficient allocation of the securities
among investors in the secondary market
• Uniform price auctions discourage this kind of
auction, because costs of participation are lower,
allowing more bidders, and the incentives of a
dealer to break out of a ring are higher, since he
only pays the uniform price, while still winning by
overbidding
Empirical Data: Difference in under
pricing between the auctions
Time of day
Discriminatory
Uniform
Difference
P-value
12:50 – 1:00
0.59
0.32
0.27
0.024
12:30 – 1:00
0.61
0.40
0.22
0.072
1:00 – 1:30
0.86
0.32
0.53
0.000
Under pricing is measured in basis points and is defined as the auction yield minus the
average when-issued yield close to the 1:00 auction time.
The auction yield is the average winning yield for discriminatory auctions and the
market-clearing yield for uniform-price auctions
Yield is reversely proportional to prices!
Conclusion
• Uniform price auctions show better results and
effectively deal with more problems
• Maximum amount of information should be
disclosed to the public
• For future research: move away from static
auctions and look into ascending or descending
auctions as they give stronger signals to the
secondary market and better information to the
participating bidders, diminishing the Winner’s
Curse, while have ambiguous effects on some of
the problems
Questoins?