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A search-based theory of the on-the-run phenomenon

By Dimitri Vayanos and Pierre-Olivier Weill

Abstract

We propose a model in which assets with identical cash flows can trade at different prices. Infinitely lived agents can establish long positions in a search spot market, or short positions by first borrowing an asset in a search repo market. We show that short-sellers can endogenously concentrate in one asset because of search externalities and the constraint that they must deliver the asset they borrowed. That asset enjoys greater liquidity, a higher lending fee ("specialness"), and trades at a premium consistent with no-arbitrage. We derive closed-form solutions for small frictions, and provide a calibration generating realistic on-the-run premia

Topics: HG Finance
Publisher: American finance association
Year: 2008
DOI identifier: 10.1111/j.1540-6261.2008.01360.x
OAI identifier: oai:eprints.lse.ac.uk:29781
Provided by: LSE Research Online
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