Odd Lots Darrell Duffie On How to Fix the World’s Most Important Market
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Aug 28, 2023 Darrell Duffie, a finance professor at Stanford's Graduate School of Business, dives into the complexities of the U.S. Treasury market. He discusses the recent volatility and liquidity challenges, highlighting its critical role in the global financial system. Duffie critiques the Federal Reserve's interventions and advocates for essential reforms, like central clearing, to enhance market efficiency. He also addresses the urgent need for better market structures amid rising government borrowing and economic pressures, emphasizing a reevaluation of traditional models.
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Volatility-Illiquidity Link
- US Treasury market volatility is the primary driver of its illiquidity.
- This relationship is consistent, with volatility explaining approximately 80% of illiquidity variations.
Wrong-Way Risk
- During crises, investors often sell the safest assets (like US Treasuries) first to reduce risk.
- This creates a surge of selling when dealers are also trying to lower their risk, exacerbating market instability.
Fed Intervention Limitations
- The Fed's interventions, like in March 2020, address immediate crises but don't solve the underlying structural issues.
- Duffie suggests that a resilient market needs to function well consistently, not just during crises.