Staff Reports
Dealers and the Dealer of Last Resort: Evidence from MBS Markets in the COVID-19 Crisis
Previous title: “Cash-Forward Arbitrage and Dealer Capital in MBS Markets: COVID-19 and Beyond”
Number 933
July 2020 Revised March 2021

JEL classification: D8, G2

Authors: Jiakai Chen, Haoyang Liu, Asani Sarkar, and Zhaogang Song

We study price dislocations and liquidity provision by dealers and the Federal Reserve (Fed) as the “dealer of last resort” in agency MBS markets during the COVID-19 crisis. As customers sold MBS to “scramble for cash,” dealers provided liquidity by taking inventory in the cash market and hedging inventory risk in the forward market. The cash and forward prices diverged significantly beyond the difference in the quality of MBS traded on the two markets. The Fed first facilitated dealers’ inventory hedging and then took holdings off dealers’ inventory directly. The price dislocations began to revert only after the Fed’s latter action, when customer selling was still strong.

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AUTHOR DISCLOSURE STATEMENT(S)
Jiakai Chen
I, Jiakai Chen, declare that I have no relevant or material financial interests that relate to the research described in the paper titled “Cash-Forward Arbitrage and Dealer Capital in the MBS Markets: COVID-19 and Beyond,” co-authored with Haoyang Liu, Asani Sarkar, and Zhaogang Song. Prior to circulation, this paper was reviewed in accordance with the Federal Reserve Bank of New York review policy, available at https://www.newyorkfed.org/research/staff_reports/index.html.

Haoyang Liu
The author declares that he has no relevant or material financial interests that relate to the research described in this paper. Prior to circulation, this paper was reviewed in accordance with the Federal Reserve Bank of New York review policy, available at https://www.newyorkfed.org/research/staff_reports/index.html.

Asani Sarkar
The author declares that (s)he has no relevant or material financial interests that relate to the research described in this paper. Prior to circulation, this paper was reviewed in accordance with the Federal Reserve Bank of New York review policy, available at https://www.newyorkfed.org/research/staff_reports/index.html.

Zhaogang Song
The author declares that he has no relevant or material financial interests that relate to the research described in this paper.
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