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 offthe-run

Markets for Treasuries

Primary market Auctions
Frequency: 4-, 13-, 26-week bills weekly, 52week, 2-, 3-, 5- and 7-year notes monthly, 10and 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 bidquantity sealed bids
Each winning competitive bidder
pays the bid he submitted
Noncompetitive bidders pay a
quantity-weighted average of the
winning competitive bids

Types of Auctions: Uniform

price
Competitive bidders place bidquantity sealed bids
Each winning competitive bidder
pays the highest loosing bid
Noncompetitive bidders pay a
quantity-weighted 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:

Winners Curse
The Winners Curse is the situation in
which the winning bidders pay more
than the shared average price of the
item
Bidders fear of the Winners Curse
makes them lower their bids
Winners Curse is directly
proportional to uncertainty

Problems with the markets:

Winners 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 Winners 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

Discrimina
tory

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

0.32

0.53

0.000

0.86

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 Winners
Curse, while have ambiguous effects on some
of the problems

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