Cross-market relations in United States financial markets

In this dissertation I examine the relation between financial markets for several different types of securities. The first chapter discusses the relevant literature concerning the relation between the stock and Treasury bond markets, as well as the relation between the repurchase agreement market for U.S. Treasuries and (1) the cash market for Treasuries and (2) the corporate bond market. The second chapter reports strong evidence that order flow in the stock and bond markets can help to explain returns in the other market. Results from a random walk variance decomposition show that in certain periods a large fraction of the variation in the efficient price of individual Treasury securities can be explained by innovations to a common factor of equity market order flow. In addition, the strength of this relation varies based on the market environment. For example, in a relatively stable environment such as November 1996, innovations to the common factor of equity order flow explain approximately 5% of the variation in the efficient price of the 5 year Treasury note. However, in a period of greater uncertainty such as August 1998, stock market order flow explains over 20% of the efficient price variation. The variance decomposition results also show that bond market order flow contributes relatively little to explaining the returns on individual stocks. The results indicate that trading activity in the stock market aggregates information about economy-wide factors that is relevant for valuing securities in the Treasury market. The third chapter presents a discussion of the general structure of the Treasury repurchase agreement ("repo") market and its linkages to other markets. First, the factors shaping repo rates for both general and specific collateral are presented. Next, results are shown which document the relation between repo market specialness and the cash market yield curve. Finally, it is shown that repo market specialness can influence both the pricing and fee structure of corporate bond issues.