Hiding in plain sight: preferred habitat effects in short-term rates *
Type
working paper
Date Issued
2024-11-06
Author(s)
Abstract
This paper investigates the failure of the expectations hypothesis (EH) in an ideal yet critical setting: repurchase (repo) agreements, the short-term funding market underlying interbank lending. I exploit a regulatory reform which shortened the settlement cycle of bond markets to identify a preferred habitat of agents using repo to fund their fixed income positions. A tripledifferences identification strategy demonstrates that this shock deteriorated the EH performance of the treated segment, implying that preferred habitat effects can distort pricing even in optimal conditions. I argue that collateral scarcity and fragmentation act as a limit to arbitrage. My results further highlight a concerning usage of repo to finance leveraged positions.
Keywords
Expectations hypothesis
preferred habitats
repo markets
term structure of interest rates JEL classification: E43
G10
G12
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open.access
Name
HidingInPlainSight_081124.pdf
Size
1.24 MB
Format
Adobe PDF
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