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1 June 2014 CFA Institute Journal Review

When Is a Treasury Security On-the-Run? (Digest Summary)

  1. Paras Gupta

Using the two existing definitions of on-the-run Treasury securities, the authors examine the securities’ trading activity and liquidity differences and conclude that there are dissimilar on-the-run periods for T-notes and T-bills. They also suggest that there is a potential impact on research studies because of the lack of clarity on the appropriate definition for an on-the-run period.

What’s Inside?

The literature acknowledges two competing definitions of on-the-run Treasury securities, and the authors empirically study the implications of each definition. They show that the run in trading activity is different between T-notes and T-bills. Examining previous papers related to their subject, they determine that the lack of clarity for the on-the run definition affects research design and conclusions.

How Is This Research Useful to Practitioners?

There are two definitions of an on-the-run period for Treasury securities, but they conflict with each other. The two definitions are (1) auction-results run period and (2) issued run period. The difference between the two definitions is simply a calendar time distinction within the Treasury auction process. The auction-results version includes the when-issued forward trading period, whereas the issued security version does not.

The authors show that T-notes exhibit high levels of trading activity during the auction-results period, but T-bill trading increases following the auction-results announcement and remains elevated until the next issue of bills. They also show that off-the-run bid–ask spreads are substantially wider than on-the-run spreads for both T-notes and T-bills. But the period of narrow spreads is different for T-bills and T-notes, and these differences align with the differences observed in trading activity.

The authors conclude that trading activity is different for T-notes and T-bills and that the auction-results on-the-run definition is appropriate for T-notes. In contrast, though, the auction-results definition for T-bills is problematic because the on-the-run levels in bid–ask spreads and their associated volumes persist past the auction announcement of the next bill.

The authors reexamine the results of two previous papers on a related subject and find inconsistency between the one run definition explicit in the text and the other elicited by the data. They highlight the need for researchers to be alert to alternative on-the-run definitions because the indiscriminate use of one definition over another can affect their research.

How Did the Authors Conduct This Research?

The authors conduct an empirical analysis to show whether the rate of absorption of newly auctioned securities into investor portfolios aligns with either the auction-results or the issued definition. The authors collect the data from all GovPX transactions for three-month T-bills and two-year T-notes that were auctioned and issued in 1997.

They use the dollar volume traded and number of trades completed to analyze the trading activity in two-year T-notes and three-month T-bills to determine when trading activity declines relative to the end of the on-the-run period. The analysis indicates that the pattern of trading activity for T-bills is different from the pattern for T-notes.

The authors next examine the bid–ask spreads for two-year T-notes. They collect the bid and ask spread associated with each transaction tick and calculate the average spread (in yield percentage points) for each day. They perform a similar exercise for notes arranged by days to maturity and then calculate the average spread by day. This result is plotted across trading days, which are identified by the GovPX activity code. Their results suggest that the on-the-run period in T-note spreads corresponds to the auction-results definition. But when they extend their process to T-bills, the results show the smallest spreads during the auction-results on-the-run period. The issued on-the-run period has larger spreads than the auction-results period, but the spreads are smaller than the spreads achieved during a distinct off-the-run period. The results suggest that the run in T-bills extends beyond the auction-results period.

Abstractor’s Viewpoint

The authors differentiate between the two competing on-the-run definitions and analyze the implications of the two definitions. They conclude that an incorrect choice by researchers could potentially affect their research. These findings would be very useful for future studies in both related and unrelated areas. Beyond further academic research, a complete understanding of time period differences in bid–ask spreads for T-notes and T-bills is undoubtedly useful to trading desks of financial institutions and corporations that deal in these securities. However, the sample period of just one year is too narrow. Future studies in this area should be conducted with a broader sample period.

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