We model the role that repurchase agreements (repos) play in bond market intermediation. Not only do repos allow dealers to finance their activities, but they also enable dealers to source assets without taking ownership. When the asset trades with repo specialness, i.e, when the associated repo rate is significantly below prevailing market rates, borrowing the asset is more expensive, resulting in higher bid-ask spreads. Limiting a single dealer’s leverage decreases its market-making abilities, so the dealer charges a higher bid-ask spread. However, limiting all dealers’ leverage reduces pressure on repo specialness, thus decreasing bid-ask spreads. More generally, this paper characterizes the importance of collateralized borrowing and lending for bond market intermediation, shows how frictions in repo markets can affect the underlying cash market liquidity, and underscores the importance of securities lending.

We study optimal securitization in the agency mortgage-backed securities (MBS) market. Many MBS are traded in the liquid to-be-announced (TBA) market, which however induces adverse selection due to cheapest-to-deliver pricing . We find that lenders pool high-value loans separately and trade them in a less liquid market. We estimate a model of MBS pooling and trading to study welfare implications of pooling policies. TBA market structure produces a trade-off between efficiency and equity; broader pooling increases liquidity and average welfare, but results in a larger cross-subsidy from smaller loans to larger loans. Minimizing costs or limiting strategic pooling results in a more regressive redistribution.

Abstract By allowing different agency mortgage-backed securities (MBS) to be traded based on limited characteristics, the to-be-announced (TBA) market generates liquidity and benefits the MBS market broadly. We quantify effects of the TBA structure on mortgage borrowers. Exploiting discontinuities in TBA eligibility, we estimate that TBA eligibility reduces mortgage rates by 7 to 28 basis points. The TBA eligibility benefit is larger for mortgages with higher expected prepayments. We also find that TBA eligibility affects refinancing, which has implications for monetary policy transmission. Our finding is relevant for housing policies, such as housing finance reforms and uniform MBS. Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.