Treasury market · 35 min
The Market Maker of Last Resort
When liquidity provision becomes a public utility, who sets the price of the option?
Overview
An argument about backstops: every liquidity backstop is a written option, somebody is short it, and the premium is almost never collected. The episode works through Treasury market interventions, central clearing proposals and what the basis trade looks like if the backstop is priced honestly. It is more about incentives than any single policy.
Key takeaways
An uncollected backstop premium is a subsidy to whoever is most levered into the trade it protects.
Central clearing changes the shape of the risk without reducing the amount of it.
The basis trade is a rates trade wearing an arbitrage costume; its size is the policy problem.
Pricing the option explicitly is the only reform that changes behaviour rather than location.
Companies & tickers
- CME
Topics
Publisher’s description
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