Central Bank–Driven Mispricing (with Marti G. Subrahmanyam, Davide Tomio and Jun Uno)

Abstract:
We use millisecond-stamped data from the Mercato dei Titoli di Stato (MTS) cash Treasury bond and the Eurex Treasury bond futures markets to show that bond purchases, undertaken under the Public Sector Purchase Program by the European Central Bank (ECB), decoupled the close link between the cash bond and futures markets, thus driving a wedge between their prices. This result is robust even after controlling for market liquidity in both the markets and overall funding liquidity. In fact, although the ECB intervened only in the cash bond market, the futures market was also affected, as the central bank’s intervention depleted market liquidity in both markets and, thus, increasing liquidity commonality. However, the impact of this dislocation on the volume of trade is ambiguous. There is a slight reduction in the volume of trade in the cash bond market, as represented by the MTS, accompanied by a large and significant increase in the volume of trade in the corresponding futures market.