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On-the-Run and Off-the-Run Bond Convergence Trades

Article Quant Q&A · Author: Anonymous
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Summary

The document names the bond trade that sells a newly issued, liquid on-the-run bond and buys an older off-the-run issue. The stated rationale is that the newest issue can command a liquidity premium, making it relatively expensive even when its other characteristics are comparable. The trade seeks to profit as that premium fades and the two issues’ prices converge.

The answer identifies the strategy as on-the-run/off-the-run arbitrage and describes it as a convergence trade. It points to research papers for further reading, but provides no data, performance estimates, or detailed trading mechanics. The explanation therefore gives the core relative-value intuition without assessing execution costs, financing, duration matching, or the risk that the liquidity premium persists or widens.

Key ideas

  • Newly issued on-the-run bonds may trade at a liquidity premium relative to older issues.
  • The trade sells the newer issue and buys a comparable older bond.
  • The intended profit comes from convergence as the newer bond’s liquidity premium declines.
  • This is a relative-value convergence trade, with risks and implementation details not quantified in the document.

Tags

Fixed incomeArbitrageRisk management
Full text
# Arbitrage with freshly issued bonds


# Arbitrage with freshly issued bonds












I recently heard someone mention an arbitrage strategy involving selling freshly issued bonds and buying the "old batch" as it has shown that the liquidity in the fresh batch motivates/drives up these prices though everything else is equal. It was supposedly used extensively by Long-term Capital Management (LTCM) in the 90ies with extreme leverage and is common knowledge in the industry.

What is the phenomena called and where can I read more about it? Papers with examples and data are highly appreciated.

## Answer by Brian Luke Duncan (score 8, accepted)

https://quant.stackexchange.com/a/9687

This is called on the run/off the run arbitrage, a type of convergence trade. The basic idea is that as the liquidity premium disappears for the on-the-run issue, the price will fall and converge to the price of previous issues. Here are a couple papers -

http://people.stern.nyu.edu/lpederse/courses/LAP/papers/SearchBargaining/VayanosWeill.pdf http://webuser.bus.umich.edu/ppasquar/onofftherun.pdf

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.