The Round-the-Clock Market for U.S. Treasury Securities
Fleming, Michael J., Federal Reserve Bank of New York Economic Policy Review
The U.S. Treasury securities market is one of the most important financial markets in the world. Treasury bills, notes, and bonds are issued by the federal government in the primary market to finance its budget deficits and meet its short-term cash-management needs. In the secondary market, the Federal Reserve System conducts monetary policy through open market purchases and sales of Treasury securities. Because the securities are near-risk-free instruments, they also serve as a benchmark for pricing numerous other financial instruments. In addition, Treasury securities are used extensively for hedging, an application that improves the liquidity of other financial markets.
The Treasury market is also one of the world's largest and most liquid financial markets. Daily trading volume in the secondary market averages $125 billion.(1) Trading takes place overseas as well as in New York, resulting in a virtual round-the-clock market. Positions are bought and sold in seconds in an interdealer market, with trade sizes starting at $1 million for notes and bonds and $5 million for bills. Competition among dealers and interdealer brokers ensures narrow bid-ask spreads for most securities and minimal interdealer brokerage fees.
Despite the Treasury market's importance, size, and liquidity, there is little quantitative evidence on its intraday functioning. Intraday analysis of trading volume and the bid-ask spread is valuable, however, for ascertaining how market liquidity changes throughout the day. Such information is important to hedgers and other market participants who may need to trade at any moment and to investors who rely on a liquid Treasury market for the pricing of other securities or for tracking market sentiment. Intraday analysis of price volatility can also reveal when new information gets incorporated into prices and shed light on the determinants of Treasury prices. Finally, analysis of price behavior can be used to test the intraday efficiency of the Treasury market by determining, for example, whether overseas price changes reflect new information that is subsequently incorporated into prices in New York.
This article provides the first detailed intraday analysis of the round-the-clock market for U.S. Treasury securities. The analysis, covering the period from April 4 to August 19, 1994, uses comprehensive data on trading activity among the primary government securities dealers.(2) Trading volume, price volatility, and bid-ask spreads are examined for the three major trading locations--New York, London, and Tokyo--as well as for each half-hour interval of the global trading day. Price efficiency across trading locations is also tested by examining the relationship between price changes observed overseas and overnight price changes in New York.
The analysis reveals that trading volume and price volatility are highly concentrated in New York trading hours, with a daily peak between 8:30 a.m. and 9 a.m. and a smaller peak between 2:30 p.m. and 3 p.m. Bid-ask spreads are found to be wider overseas than in New York and wider in Tokyo than in London. Despite lower overseas liquidity, overseas price changes in U.S. Treasury securities emerge as unbiased predictors of overnight New York price changes.
THE STRUCTURE OF THE SECONDARY MARKET
Secondary trading in U.S. Treasury securities occurs primarily in an over-the-counter market rather than through an organized exchange.(3) Although 1,700 brokers and dealers trade in the secondary market, the 39 primary government securities dealers account for the majority of trading volume (Appendix A).(4) Primary dealers are firms with which the Federal Reserve Bank of New York interacts directly in the course of its open market operations. They include large diversified securities firms, money center banks, and specialized securities firms, and are foreign- as well as U.S.-owned. Over time, the number of primary dealers can change, as it did most recently with the addition of Dresdner Kleinwort Benson North America LLC. …