Underpricing in treasury auctions

Finance

IFA Working Paper

1997

This paper examines the degree to which the auction mechanism is responsible for underpricing in U.S. Treasury auctions. The price received by the Treasury in this primary market is, on average, less than the price of the same securities in the concurrent secondary market. The discriminatory auction is modeled as a common-value auction in which bidders have no market power and receive noisy signals of the true value of the security. I show that underpricing is a natural result of the discriminatory price mechanism used in Treasury auctions. In contrast, uniform-price auctions should not result in any underpricing. The equilibrium level of underpricing in a discriminatory auction can be predicted from the summary statistics released by the Treasury after the auction. Empirical results from a new source of data show that the magnitude of underpricing in discriminatory auctions is consistent with the model. However, contrary to the theory we also observe underprincing in uniform-price auctions.

Institute of Finance and Accounting

FIN 263

IFA Working Paper

No