An Empirical Study of the Indian Treasury Securities Primary Auctions Golaka C Nath1 Abstract

The study has attempted to empirically examine the efficiency of Govt. securities auction in Indian market. It is observed that prices of the securities under auction generally move downward between the date of announcement of auction and the date of auction. The yield, duration, issue size, outstanding stocks of the security under auction have significant impact of the price changes of auctioned securities. Introduction of an open limit order book system for Government securities market has been found to be statistically significant. Before the introduction of NDS-OM, the average price change was 1.89% while after introduction of NDS-OM, the same came down drastically to 0.87%.

Keywords: Primary Auctions, Secondary Markets, Treasury Securities JEL: D440

February 20072

1 2

VP, CCIL contact email id: gcnath@ccilindia.co.in Preliminary Draft. Please do not quote without authors written permission.

An Empirical Study of the Indian Treasury Securities Primary Auctions

The Indian gilts market is in the domain of the central bank of the country as it is not only involved in the primary auctions but also takes part in the secondary market at the time of need. The primary auction of Government of India securities is managed by the Reserve Bank of India (RBI) under the provided statutes. In order to moderate liquidity and ensuring monetary policy achieve its stated objectives, the RBI is also authorized to conduct open market operations as well as Repo and Reverse Repo under daily Liquidity Adjustment Facility3 (LAF) that involves treasury securities. The RBI has bee effectively managing public debt and has been able to raise resources for the Government which has been borrowing increasingly higher amounts to fund the fiscal deficit. Management of public debt by the RBI involved many policy considerations that include minimization of cost of borrowing, ensuring wider distribution of ownership of government securities to broaden the market depth and helping to develop a robust secondary market for gilts. The primary auction market has been successful due to participation of fairly large number of market participants (mainly banks and primary dealers) in the auctions and underwriting of debt by primary dealers. The new underwriting format introduced by the RBI effective from April06 (after Fiscal Responsibility and Budget Management Act came into effect) is likely to add impetus to efficiency to the primary auction market. The introduction of a When-Issued Market in dated securities in terms of the announcements made in the Annual Credit Policy of RBI is a welcome step in the right direction. The RBI comes out with issuance calendar for both T-bills and dated securities well in advance in order to help the market participants to plan their cash flows. Depending on market conditions, the RBI conducts multiple or uniform price auctions of the dated treasury securities. The RBI has been following the programme of an active

LAF was introduced by RBI in June 2000 to infuse/absorb liquidity from the system on daily basis using Repo and Reverse Repo with banks and primary dealers. The eligible securities are bonds issued by Govt. of India.

consolidation of Government debt by re-issuing the existing papers since last couple of years. The auctions are mostly price-based. The secondary market for Government of India securities is fairly liquid for few benchmark securities while most of the issued securities trade irregularly. The secondary market has a well functioning trading system with availability of three alternate forms of trading. (a) The broker driven deals which used to contribute nearly 80% of the total trading before Aug05 still exits but with 13% market share. (b) The direct bilateral deals between the banks and institutions through a voice market contribute about 9% of the market. (c) The new anonymous open limit order book system (commonly known as Negotiated Dealing System Order Matching (NDS-OM)) introduced by the RBI in Aug05 constitutes 78% of the trading in the market. Due to anonymity of the new system, it has become convenient for the RBI to participate in the secondary market from time to time. The same was not possible earlier as market was completely a telephone based one. The secondary market has a robust centralized clearing and settlement system with guarantee of settlement provided a central counterparty. The central counterparty service is run by Clearing Corporation of India Ltd. (CCIL) which was set up in Feb 2002. The CCIL charges adequate margins from banks and institutions for guarantees the settlement of the trades executed in gilts market. Driving down the price in the secondary market of an existing security going for auction is a common finding which has arisen from the growing body of empirical evidence on government debt auctions. The central banks and other relevant regulators monitor the market movements in gilts because both theory and experience suggest the persistence of the phenomenon of driving down the price. The markets vulnerability to manipulation makes it relevant for regulators to have a keen watch on the secondary market for a security going for the auction. The ultimate concern of the regulators is that market manipulability may undermine the price-discovery process which will lead to loss of public confidence in the efficiency and integrity of the market. The consistent attention of the regulators and central banks have resulted in innovations in the fixed income securities markets across the globe.

Earlier literature have found the incidence of under-pricing of auctioned security in the government securities markets of developed countries like the United States, Canada, United Kingdom, Germany, Switzerland, Italy or Spain, at least. The objective of this paper is to study the efficiency of auction prices in India and understand how the spread of auction price over the secondary market price of the concerned security, if any, is determined by the market. The rest of this paper is structured as follows. Section 2 discusses the auctions in Government of India securities in recent years. Section 3 sketches some characteristics of the price dynamics of auctioned securities. Section 4 describes price realization and secondary market price of the auctioned securities as well as the price behaviour between date of auction announcement and auction date. Section 5 presents the results and gives the explanation of the price change between auction notification and auction date. Lastly, section 6 summarizes our main conclusions and suggests some venues for further research. 2. Auction in Past Two Years The most important achievement of the RBI has been the stability of interest rate during last 5 years or so. The bond market has not witnessed any dramatic fall or rise of interest rate during this period. The falling interest rate during the last decade has come as a relief for the Government as it could borrow money at lower rates. The RBIs monetary policy has helped in bringing down the interest rate and reduced the cost of debt for the government and in the process elongated the maturity structure of the government dept as depicted in Table-1.
Table -1: Loans issued by Government Weighted Average of maturity of Range of Weighted Maturities of Average Outstanding New Loans Maturity Stocks 5-25 14.30 8.20 7-30 13.80 8.90 4-30 14.94 9.80 5-30 14.13 9.63 Weighted Average Yield of Outstanding Stocks 10.84 10.44 9.30 8.79

Year 2001-02 2002-03 2003-04 2004-05

Weighted Average Yield 9.44 7.37 5.71 6.11

2005-06 7.34 5-30 16.90 9.92 2006-07 7.92 4-30 12.73 10.12 Source: RBI (All periods are from April to March). The 2006-07 period covers upto August06.

8.75 8.64

During 2004-05, the Government issued dated securities (excluding floating rate and embedded option bonds) worth of Rs.58000crores which included only 2 new issues 5.59% GS2016 and 7.5% GS2034 and the rest were re-issuances of existing securities. There were 15 auctions involving 10 dated securities during the year. It involved only 1 uniform price auctions for the then new long maturity security 7.5% GS2034 while all other auctions were multiple price auctions. During 2005-06, the Government issued dated securities worth of Rs.121,000crores that included only 1 new security - 7.40% GS 2035. There were 29 auctions involving 14 securities during the year. However, there were 4 instances of uniform price auctions while rests were multiple price auctions. Table-2 gives the details of auctions in last two financial years (April to March). Table -2: Auction of Treasury Securities (Apr'04 to Mar'06)
Date of Issue 06-May-04 03-Jun-04 03-Jun-04 17-Jun-04 17-Jun-04 01-Jul-04 09-Aug-04 08-Sep-04 08-Sep-04 11-Oct-04 08-Nov-04 08-Nov-04 04-Jan-05 04-Jan-05 07-Feb-05 05-Apr-05 05-Apr-05 19-Apr-05 19-Apr-05 03-May-05

Notified Amount (Rs. Crore) 3000 6000 4000 3000 6000 2000 2000 3000 3000 6000 6000 2000 2000 5000 5000 5000 3000 5000 2000 2000

Security 6.01% G. S 2028 5.59% G. S 2016 6.01% G. S 2028 6.13% G. S 2028 7.38% G.S 2015 6.13% G. S 2028 7.5% G. S 2034 6.65% G.S. 2009 8.35% G.S. 2022 7.38% G.S 2015 7.55% G.S. 2010 7.95% G.S 2032 7.5% G. S 2034 9.39% G. S. 2011 8.35% G.S. 2022 6.85% G.S. 2012 7.95% G.S 2032 8.07% GS 2017 7.5% G. S 2034 7.5% G. S 2034

Date of Notice 30-Apr-04 28-May-04 28-May-04 14-Jun-04 14-Jun-04 29-Jun-04 04-Aug-04 06-Sep-04 06-Sep-04 08-Oct-04 04-Nov-04 04-Nov-04 31-Dec-04 31-Dec-04 02-Feb-05 01-Apr-05 01-Apr-05 15-Apr-05 15-Apr-05 29-Apr-05

Cut off Yield (%) 5.7930 5.5900 6.2348 6.2900 5.5842 6.7039 7.5000 5.8976 7.1378 6.9872 7.1974 8.2423 7.1085 6.5154 7.3427 6.8044 7.7933 7.4847 7.9406 7.9796

Cut off price (Rs.) 102.78 100 97.22 98.03 114.8 93.2 100 102.97 112.05 102.95 101.58 96.81 104.8 115.02 109.75 100.25 101.75 104.5 95 94.58

Weighted Average Auction Price (Rs.) 102.84 97.58 98.34 114.92 93.38 103.12 113.07 103.23 101.7 97.71 105.22 115.19 111.05 100.33 103.01 95.29 94.9

Type Category Reissue New Issue Reissue Reissue Reissue Reissue New Issue Reissue Reissue Reissue Reissue Reissue Reissue Reissue Reissue Reissue Reissue Reissue Reissue Reissue

M M M M M M U M M M M M M M M M M U M M

1 crore is 10,000,000 M and U indicate Multiple and Uniform Price Auctions respectively

03-May-05 24-May-05 06-Jun-05 06-Jun-05 23-Jun-05 05-Jul-05 05-Jul-05 18-Jul-05 11-Aug-05 11-Aug-05 18-Aug-05 18-Aug-05 08-Sep-05 08-Sep-05 06-Oct-05 08-Nov-05 08-Nov-05 24-Nov-05 06-Dec-05 06-Dec-05 09-Jan-06 09-Jan-06 07-Feb-06 07-Feb-06

6000 4000 4000 6000 5000 4000 6000 5000 3000 5000 5000 3000 3000 5000 3000 5000 3000 5000 3000 5000 6000 4000 3000 3000

7.55% G.S. 2010 8.35% G.S. 2022 10.25% G. S. 2021 7.37% G.S. 2014 7.49% G. S. 2017 10.25% G. S. 2021 7.27% G.S 2013 10.25% G. S. 2021 7.5% G. S 2034 8.07% GS 2017 7.37% G.S. 2014 7.5% G. S 2034 7.40% G.S 2035 5.69% G. S 2018 7.40% G.S 2035 7.49% G. S. 2017 7.40% G.S 2035 8.35% G.S. 2022 7.40% G.S 2035 8.07% GS 2017 9.39% G. S. 2011 7.40% G.S 2035 7.46% G.S. 2017 7.40% G S 2035

29-Apr-05 20-May-05 02-Jun-05 02-Jun-05 20-Jun-05 01-Jul-05 01-Jul-05 14-Jul-05 05-Aug-05 05-Aug-05 16-Aug-05 16-Aug-05 02-Sep-05 02-Sep-05 03-Oct-05 02-Nov-05 02-Nov-05 21-Nov-05 01-Dec-05 01-Dec-05 04-Jan-06 04-Jan-06 02-Feb-06 02-Feb-06

6.9916 7.2826 7.4677 6.9096 6.9120 7.5660 7.0620 7.8060 7.4449 7.1405 7.0383 7.5476 7.4000 7.2310 7.6560 7.3258 7.7282 7.4305 7.5547 7.2412 6.6964 7.4323 7.3810 7.6330

102.33 110.3 125.71 103 104.6 124.57 101.26 122 100.65 107.17 102.11 99.44 100 87.12 97 101.25 96.18 108.65 98.16 106.24 112.18 99.6 100.6 97.27

102.4 110.3 126.76 103.12 104.76 125.36 101.37 122.14 100.81 107.33 102.18 99.94 87.55 97.09 96.88 108.78 98.39 106.31 112.27 99.79 98.06

Reissue Reissue Reissue Reissue Reissue Reissue Reissue Reissue Reissue Reissue Reissue Reissue New Issue Reissue Reissue Reissue Reissue Reissue Reissue Reissue Reissue Reissue Reissue Reissue

M M M M M M M M M M M M U M M U M M M M M M U M

Primarily, the Government has been re-issuing the existing securities to increase the floating stock in the market so that liquidity in the secondary market is improved. The auction also tries to lengthen the maturity structure. 3. Price Dynamics We have attempted to study the price dynamics of the market on auction days. Normally, auction results are declared in the evening. The market trading is almost over by that time though at times we observe spurt in activity before the market closes on the auction day. At times on auction days, market timing is extended little bit to accommodate the trades of the market participants. Normally the auction notice is issued by the central bank about a week before the auction date. Auction process entails submission of closed bids by market participants in the morning (normally by 12.30PM). While submitting the bids, the bidding entities are guided by market prices at the relevant time. The market prices

are available from the reported information at RBI Negotiated Dealing System (NDS) or the new NDS-Order Matching system (NDS-OM). If the market price is not available because the concerned security is not traded inn the market before submission of a bid by a bank, the bidding entity has to price the bid using its own estimation as the yield curve is availabe. Generally, auctioned securities (re-issues) are expected to have higher volume of trade in secondary market on the date of auctions. During FY 2004-05, there was only one auction (GS 2028 6.01% on 06-May-2004) in which the cut-off price in auction was higher than the weighted average traded price (by Rs0.05) of the concerned security on the auction day. During this period, no secondary market deal was reported on the auction day for three auctioned securities (GS2028 6.13% on 01-Jul-2004, GS2022 8.35% on 08-Sep-2004, GS 2034 7.50% on 04-Jan2005). In case of a one particular security (7.95% G.S 2032), the cut-off price was Rs.1.78 lower than the secondary market weighted average traded price of the security. The difference between cut-off price and weighted average traded price in the secondary market varied from Rs.0.18 to Rs.1.78. The average price difference was Rs.0.69. However, during this period, the weighted average price realized by the Government from the auction process was lower than the weighed average traded price in the secondary market on auction days. There were 3 cases in which the price realization by the Govt. was higher than the secondary market traded prices (the difference varied from Rs.0.05 to Rs.0.31) while there were 7 cases in which the price realization was lower than the secondary market traded price (the difference varied from rs.0.06 to Rs.0.88). During FY 2005-06, there were only 2 auctions in which cut-off price in auctions were higher than the secondary market weighted average traded price (by Rs.0.02 and Rs.0.03) while in 22 cases, the cut-off price in auctions were lower than the secondary market weighted average traded price (the difference varied between Rs.1.05 and Rs.0.03). There were 4 cases in which the securities put in for auction were not traded in the secondary market on auction dates. However, out of 23 comparable cases (in case secondary market trade happened on auction days), in 11 cases, weighted average price realization in auctions were lower than the secondary market weighted average traded price while in 12

cases the weighted price realization in auctions were higher than the secondary market weighted average traded price . 4. Price Realization and Secondary Market Price The market participants generally submit their closed bids for the auctions before 12.30PM when the secondary market is open and hence secondary market price is an indicator of the comparative price realization for the Govt. The Table-2 gives the difference between the realized price in auctions and comparable secondary market price (weighted average). Out of total 34 cases of auction during the 24 month period (April04 and Mar06) under our consideration; we observe in 16 cases that the auction price realization for the Govt. was higher than the weighted average secondary market price. In 18 cases, the price realizations in auctions were relatively lower than the secondary market traded price of the auctioned security.

Table - 2: Price Comparison between Auction realized price and Secondary market price Weighted Average auction Price 102.84 97.58 98.34 114.92 103.12 103.23 101.7 97.71 115.19 111.05 104.5 94.9 102.4 126.76 103.12 104.76 125.36 101.37 122.14 100.81 107.33 102.18 99.94 87.55 97.09 Weighted Avg. traded price 102.73 97.97 98.03 114.98 103.29 103.94 102.11 98.59 115.40 111.00 105.55 95.41 102.52 126.30 103.06 104.67 124.99 101.32 122.76 100.75 107.29 102.19 99.98 87.42 97.64

Date of Issue 06-05-04 03-06-04 17-06-04 17-06-04 08-09-04 11-10-04 08-11-04 08-11-04 04-01-05 07-02-05 19-04-05 03-05-05 03-05-05 06-06-05 06-06-05 23-06-05 05-07-05 05-07-05 18-07-05 11-08-05 11-08-05 18-08-05 18-08-05 08-09-05 06-10-05

Notified Amount 3000 4000 3000 6000 3000 6000 6000 2000 5000 5000 5000 2000 6000 4000 6000 5000 4000 6000 5000 3000 5000 5000 3000 5000 3000

Security 6.01% G. S 2028 6.01% G. S 2028 6.13% G. S 2028 7.38% G.S 2015 6.65% G.S. 2009 7.38% G.S 2015 7.55% G.S. 2010 7.95% G.S 2032 9.39% G. S. 2011 8.35% G.S. 2022 8.07% GS 2017 7.5% G. S 2034 7.55% G.S. 2010 10.25% G. S. 2021 7.37% G.S. 2014 7.49% G. S. 2017 10.25% G. S. 2021 7.27% G.S 2013 10.25% G. S. 2021 7.5% G. S 2034 8.07% GS 2017 7.37% G.S. 2014 7.5% G. S 2034 5.69% G. S 2018 7.40% G.S 2035

Date of Notice 30-Apr-04 28-May-04 14-Jun-04 14-Jun-04 06-Sep-04 08-Oct-04 04-Nov-04 04-Nov-04 31-Dec-04 02-Feb-05 15-Apr-05 29-Apr-05 29-Apr-05 02-Jun-05 02-Jun-05 20-Jun-05 01-Jul-05 01-Jul-05 14-Jul-05 05-Aug-05 05-Aug-05 16-Aug-05 16-Aug-05 02-Sep-05 03-Oct-05

Cut off price 102.78 97.22 98.03 114.8 102.97 102.95 101.58 96.81 115.02 109.75 104.5 94.58 102.33 125.71 103 104.6 124.57 101.26 122 100.65 107.17 102.11 99.44 87.12 97

Difference 0.11 -0.39 0.31 -0.06 -0.17 -0.71 -0.41 -0.88 -0.21 0.05 -1.05 -0.51 -0.12 0.46 0.06 0.09 0.37 0.05 -0.62 0.06 0.04 -0.01 -0.04 0.13 -0.55

Profit/Loss (Rs. Cr) 3.40 -15.70 9.30 -3.68 -4.98 -42.41 -24.52 -17.68 -10.60 2.50 -52.50 -10.16 -7.10 18.36 3.54 4.48 14.80 2.80 -30.90 1.80 2.20 -0.67 -1.29 6.46 -16.64

08-11-05 08-11-05 24-11-05 06-12-05 06-12-05 09-01-06 09-01-06 07-02-06 07-02-06 Total

3000 5000 5000 3000 5000 4000 6000 3000 3000

7.40% G.S 2035 7.49% G. S. 2017 8.35% G.S. 2022 7.40% G.S 2035 8.07% GS 2017 7.40% G.S 2035 9.39% G. S. 2011 7.40% G.S 2035 7.46% G.S. 2017

02-Nov-05 02-Nov-05 21-Nov-05 01-Dec-05 01-Dec-05 04-Jan-06 04-Jan-06 02-Feb-06 02-Feb-06

96.18 101.25 108.65 98.16 106.24 99.6 112.18 97.27 100.6

96.88 101.25 108.78 98.39 106.31 99.79 112.27 98.06 100.6

97.06 101.22 108.71 98.47 106.32 99.63 112.24 98.07 100.58

-0.18 0.03 0.07 -0.08 -0.01 0.16 0.03 -0.01 0.02

-5.34 1.73 3.30 -2.52 -0.38 6.27 1.97 -0.29 0.75 -163.70

We have tried to study the price dynamics of auctioned securities between the date of auction notice and date of auction. There were few auctioned securities where no trades were reported during the period between the date of announcement of auction and date of actual auction. Mostly such securities were long maturity ones (maturing in 2028/2034/2035). Generally there is a trend of price decline for a security once the auction is announced by the RBI. During 2004-05, we find in 8 out of 10 cases that there was drop in price for the auctioned security between the date of auction announcement and date of auction while for 2 securities, there was a price enhancement. During the said period, we took the most liquid security on comparable dates and find that there was a drop in price of the most liquid security in comparable period only in 4 cases while for other 6 cases, there was a price improvement for the most liquid securities. For FY200506, in 15 out of 19 cases we find that there was a drop in price for the auctioned securities between the date of auction announcement and date of auction while there was a price enhancement for 4 securities, It is interesting to note that the prices of most of the securities put up for auction are hammered down soon after the date of announcement of auction. Compared to this, the most liquid securities on the comparable dates have either improved their prices or fallen comparatively less. This implies that auctioned securities are at times targeted for hammering so that the market participants would get a higher yield. It is observed that in 6 out of 29 comparable instances, there had been price improvement during the period between the announcement and date of auction. Such price improvement varied from 0.02% to 0.65%. In the case of 23 auctions, the price declines varied between 9.04% and 0.06%. It is noticeable that a security (GS2032 7.95%) lost about 9% in value in a short

period of time. Table-3 gives the price dynamism between announcement date and auction date for selected securities.

Table - 3: Price Dynamism between Announcement Date and Auction date Date close to Announcem ent Date/Date of announceme nt 30-Apr-04 01-Jun-04 14-Jun-04 14-Jun-04 07-Sep-04 08-Oct-04 02-Nov-04 04-Nov-04 31-Dec-04 25-Jan-05 12-Apr-05 28-Apr-05 29-Apr-05 04-Jun-05 01-Jul-05 28-Jun-05 14-Jul-05 04-Aug-05 05-Aug-05 16-Aug-05 12-Aug-05 29-Sep-05 02-Nov-05 03-Nov-05 01-Dec-05 01-Dec-05 04-Jan-06 Most Liquid Security price on Announc ement date 124.61 121.45 119.95 119.95 110.5 105.75 103.29 103.29 105.67 104.67 99.81 104.12 104.06 100.22 103.06 102.24 100.92 125.6 125.41 102.08 102.55 125.68 102.54 102.1 126.01 126.01 106.69 Price of Most Liquid Sec on Auction date 124.9 121.5 120.47 120.47 110.6 103.45 100.64 100.64 106.64 106.06 99.89 104.46 104.46 100.26 102.17 101.23 101.38 125.69 125.69 102.18 102.18 125.57 102.3 101.28 126.16 126.16 106.65

Date of Issue 06-0504 03-0604 17-0604 17-0604 08-0904 11-1004 08-1104 08-1104 04-0105 07-0205 19-0405 03-0505 03-0505 06-0605 05-0705 05-0705 18-0705 11-0805 11-0805 18-0805 18-0805 06-1005 08-1105 08-1105 06-1205 06-1205 09-01-

Security 6.01% G. S 2028 6.01% G. S 2028 6.13% G. S 2028 7.38% G.S 2015 6.65% G.S. 2009 7.38% G.S 2015 7.55% G.S. 2010 7.95% G.S 2032 9.39% G. S. 2011 8.35% G.S. 2022 8.07% GS 2017 7.5% G. S 2034 7.55% G.S. 2010 10.25% G. S. 2021 10.25% G. S. 2021 7.27% G.S 2013 10.25% G. S. 2021 7.5% G. S 2034 8.07% GS 2017 7.37% G.S. 2014 7.5% G. S 2034 7.40% G.S 2035 7.40% G.S 2035 7.49% G. S. 2017 7.40% G.S 2035 8.07% GS 2017 7.40% G.S 2035

Weighted Avg. traded price 102.73 97.97 98.03 114.98 103.29 103.94 102.11 98.59 115.4 111 105.55 95.41 102.52 126.3 124.99 101.32 122.76 100.75 107.29 102.19 99.98 97.64 97.06 101.22 98.47 106.32 99.63

Price Close to Announ cement date 102.06 99.8 98.01 115.05 103.47 106.36 104 108.39 114.72 113.75 107.16 97.28 103.25 127.89 127.01 102.24 123.96 100.33 107.6 102.17 100.59 99.45 99.01 102.1 98.22 106.41 99.6

%price Change 0.65 -1.83 0.02 -0.06 -0.18 -2.28 -1.82 -9.04 -0.59 -2.42 -1.5 -1.92 -0.71 -1.24 -1.59 -0.9 -0.97 0.42 -0.29 0.03 -0.6 -1.82 -1.97 -0.87 0.26 -0.09 0.03

% Cha nge 0.23 0.04 0.43 0.43 0.09 2.17 2.57 2.57 0.92 1.33 0.08 0.33 0.39 0.04 0.86 0.98 0.45 0.07 0.23 0.1 0.36 0.09 0.23 0.81 0.12 0.12 -

Most Liquid Security as on Date of Issue 8.07% GS 2017 8.07% GS 2018 8.07% GS 2017 8.07% GS 2017 7.38% G.S 2015 7.38% G.S 2015 7.38% G.S 2015 7.38% G.S 2015 7.38% G.S 2015 7.38% G.S 2015 6.85% G.S. 2012 8.07% GS 2017 8.07% GS 2017 6.85% G.S. 2012 7.37% G.S 2014 7.27% G.S 2013 7.27% G.S 2013 10.25% G. S. 2021 10.25% G. S. 2021 7.37% G.S. 2014 7.37% G.S. 2014 10.25% G. S. 2021 7.37% G. S. 2014 7.49% G. S. 2017 10.25% G. S. 2021 10.25% G. S. 2021 8.07% G. S. 2017

10

06 09-0106 07-0206

9.39% G. S. 2011 7.46% G.S. 2017

112.24 100.58

112.43 101.7

-0.17 -1.11

05-Jan-06 02-Feb-06

112.43 105.09

112.2 105.52

0.04 0.21 0.41

9.39% G. S. 2011 8.07% G.S 2017

5. What explains the Price Change between Auction notification and Auction Date? The data clearly shows that normally prices of securities under auction take a slide once the auction is announced irrespective of whether the market in general is moving down or not. For example, in Feb05, the price of auctioned security GS2022 8.35% declined by 2.42% from Rs.113.75 to Rs.111.00 (auction cut-off price was Rs.109.75 and weighted average realization from auction was Rs.111.05) during the period from auction announcement and auction date even though the price of the most liquid security GS2015 7.38% increased by 1.33% from Rs.104.67 to Rs.106.06. It is required to look at factors that explain such price changes. Among the important factors that can have bearing on the auction market, the following few are most important: liquidity condition in the market, coupon, duration, yield, outstanding stocks and size of auction. We have not taken auction type as a dummy variable as most of the auctions under our study are multiple price auctions. However, we have used a dummy variable to understand if introduction of Negotiated Dealing System Order Matching Module (NDS-OM) in Aug05 had any impact on the price changes. NDS-OM platform is an order matching anonymous trading platform for Govt. bonds. The price discovery is on real time basis and soon after its introduction; this segment dominated the market with more than 60% of the market share. The risk can be measured by the duration of the security. Liquidity is an important measure. If there is enough liquidity in the system, there would be more participation in the auction and hence the range would be lower. We have framed our regression equation as
price _ change = + * size + * liquidity + * duration + * coupon + * yield + * type +

..(1)

The result of the regression is given in Table-4. The results indicate that the yield of the security auctioned plays an important role and has a negative relationship with the price change. If the yield of the auctioned security is high, the price change is low and vice versa. The introduction of NDS-OM has been found to be significant indicating structural 11

change in the auction outcomes after introduction of order based secondary market dealing system. Table-4 : Regression Results DF Estimate Standard t Value Approx Error Pr > |t| Intercept 1 -4.75488 23.28662 -0.20 0.8402 Size 1 2.27498 1.53217 1.48 0.1525 Outstanding size 1 -1.08955 1.02943 -1.06 0.3019 Duration 1 0.87620 1.02695 0.85 0.4032 Yield 1 -170.19294 59.13750 -2.88 0.0090** Liquidity 1 0.06554 0.90983 0.07 0.9433 Coupon 1 38.98936 34.80053 1.12 0.2752 Type 1 1.98659 0.79930 2.49 0.0214* Adj. R-Square = 0.3338, * and **indicates significant at 5% and 1% level, n = 29 Variable In order to understand the effects better, we divided the entire period into two parts: (a) the period during which the auction used to be conducted sans NDS-OM and (b) the period during which the auction used to be conducted with the introduction of NDS-OM. The results for the first sub-period are in Table-5. It indicates that size of the issue has been significant and smaller the size of issuance, the smaller is the price change indicating liquidity might be impacting the auction of the security. However, outstanding issue size has been negatively related to the price change indicating higher the outstanding issue size (more broad based the distribution of the stock) meant lower price change. This is a sign of market efficiency market participants pricing the security more effectively and if secondary market price is attractive, participants would like to pick it up and making the system more competitive. The result also showed that coupon of the stock is significant at 10% level which indicates that higher coupon security may attract higher price change and lower coupon security attracts lower price change. Variable Intercept Size Outstanding size Duration Yield Liquidity Table-5 : Regression Results sans NDS-OM DF Estimate Standard t Value Approx Error Pr > |t| 1 4.78627 28.59328 0.17 0.8704 1 6.90784 2.88037 2.40 0.0374* 1 -5.37489 2.44055 -2.20 0.0522*** 1 2.99809 1.77665 1.69 0.1224 1 -131.69238 75.45595 -1.75 0.1115 1 -0.66376 1.15202 -0.58 0.5772

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Coupon Adj. R-Square =

1 94.24434 46.96115 2.01 0.0726*** 0.4502, * and *** indicates significant at 5% and 10% level n = 17

The results for the second sub-period are in Table-6. This shows that markets have shifted to a risk based methods for pricing the security. The results indicate that the yield of the security auctioned plays an important role and has a negative relationship with the price change. If the yield of the auctioned security is high, the price change is low and vice versa. The duration of the security is positively related to price change higher the duration of the security, higher the price-change. This indicates that after introduction of NDS-OM, market participants effectively price the risk of a security while participating in the auction. Table-6 : Regression Results after introduction of NDS-OM Variable DF Estimate Standard t Value Approx Error Pr > |t| Intercept 1 24.23412 30.60587 0.79 0.4644 Size 1 -0.99278 1.28094 -0.78 0.4734 Outstanding size 1 1.11839 0.68947 1.62 0.1657 Duration 1 4.08012 1.50964 2.70 0.0426* Yield 1 -565.17134 219.54689 -2.57 0.0498* Liquidity 1 0.26601 0.81531 0.33 0.7574 Coupon 1 -19.54076 52.86764 -0.37 0.7268 Adj. R-Square = 0.5044, * indicates significant at 5% level, n = 12 From the above results, we find that factors like yield, duration, issue size, outstanding stocks of the security under auction are significant and explain the price change in a security during the period between the date of announcement of the auction and date of actual auction of the security. We also find that introduction of NDS-OM is a statistically significant event. Before the introduction of NDS-OM, the average price change (only absolute values) was 1.89% and after introduction of NDS-OM the same came down drastically to 0.87%. 6. Concluding Remarks During the period of our study, we find that out of 29 auctions under study, only 7 instances show that price change in a liquid security is lower than the price change in the auctioned security. In most of the cases, the price change in the auctioned security is 13

higher than the most liquid security at that period. The study has attempted to empirically examine the efficiency of Govt. securities auction in Indian market. It is observed that prices of the securities under auction generally move downward between the date of announcement of auction and the date of auction. The yield, duration, issue size, outstanding stocks of the security under auction have significant impact of the price changes of auctioned securities. Introduction of NDS-OM have been found to be statistically significant. Before the introduction of NDS-OM, the average price change (only absolute values) was 1.89% while after introduction of NDS-OM, the same came down drastically to 0.87%. With the introduction of When Issued market, market participants would be able to trade on the security to be auctioned before actual auction date. The when issued market remains open for about 7 days and the same will get synchronized with the normal market on the date of auction. The settlement of the auctioned security will be clubbed with the normal settlement on the auction day. The provision of net short selling allowed to primary dealers would help better price discovery in the market. With a vibrant when issued market, the prices are expected to be stable and the price of the auction security will be in sync with the price movement of other securities in the market. 7. Bibliography Amihud, Y. and H. Mendelson (1986),Asset Pricing and the Bid-Ask Spread, Journal of Financial Economics 17, 1986, 223-249. Ausubel, L. (1997), An Efficient Ascending-Bid Auction, University of Maryland, Department of Economics Working Paper No. 97-06, June 25, 1997. Ausubel, L. and P. Cramton (1998), Auctioning Securities, University of Maryland, Mimeograph, March 1998. Ausubel, L. and P. Cramton (1999), Vickrey Auctions with Reserve Pricing, University of Maryland, Mimeograph, June 1999. Babatz, G. (1997), Ownership Structure, Capital Structure and Investment in Emerging Markets: The Case of Mexico, Ph. D. Dissertation, Harvard, December 1997.

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Bartolini, L. and C. Cottarelli (1994), Treasury Bill Auctions: Issues and Uses, International Monetary Fund WP/94/135, November 1994. Bihkchandani, S. and C. Huang (1993), The Economics of Treasury Securities Markets, Journal of Economic Perspectives, Volume 7, Number 3, Summer 1993, 117134. Branch, B. and W. Freed (1977), Bid-Asked Spreads on the AMEX and the Big Board, Journal of Finance, Volume 32, Issue 1 (Mar 1977), 159-163. Breedon, F. and J. Ganley (1996), Bidding and Information: Evidence from Gilt- Edged Auctions, Bank of England, Working Paper Series No. 42, January 1996. Brennan, M. J. and A. Subrahmanyam (1998), The Determinants of Average Trade Size, Journal of Business, 1998, vol. 71, no. 1. Copeland, T. E. and D. Galai (1983), Information Effects on the Bid-Ask Spread, The Journal of Finance, vol. XXXVIII, No. 5, December 1983. Castellanos Sara G. (2001), A New Empirical Study of the Mexican Treasury Securities Primary Auctions: Is there more underpricing? Mimeograph, Banco de Mxico Debt Management Report 2000-01, Her Majestys Treasury, United Kingdom, March 2000. Feldman, R. and V. Reinhart (1995), Auction Format Matters: Evidence on Bidding Behavior and Seller Revenue, IMF Working Paper 95/47. Gordy, M. B. (1996), Hedging Winners Curse with Multiple Bids: Evidence from the Portuguese Treasury Bill Auction, Banco de Portugal, Estudos E Documentos de Trabalho Working Papers, WP 21-96, December 1996. Haile, P. (1997), Auctions with Private Uncertainty and Resale Opportunities, University of Wisconsin-Madison, Department of Economics, Mimeograph, December 1997. Haile, P. (1999), Auctions with Resale, University of Wisconsin-Madison, Department of Economics, Mimeograph, October 1999. Hardy, D. C. (2000), Bidding Behavior on Treasury Bill Auctions: Evidence from Pakistan, IMF Working Paper WP/00/111, June 2000. Harvey, N. (1999), Recent Initiatives in the Canadian Market for Government of Canada Securities, Bank of Canada Review, Summer 1999.

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Heller, D. and Y. Lengwiler (1998), The Auctions of Swiss Government Bonds: Should the Treasury Price Discriminate or Not?, Federal Reserve Board, Finance and Economics Discussions Series 1998-11. Joint Report on the Government Securities Market, Department of the Treasury, Securities and Exchange Commission, and Board of Governors of the Federal Reserve System, United States of America, January 1992. Kennedy, P. (1993), A Guide to Econometrics, MIT Press, third printing. Lengwiler, Y. (1999), The multiple unit auction with variable supply, Economic Theory 14, 373-392. Mazn, C. and S. Nez (1999), On the optimality of treasury bond auctions: the Spanish case, Banco de Espaa, Documento de Trabajo no. 9905, 1999. Nandi, S. (1997), Treasury Auctions: What do the Recent Models and Results Tell Us?, Federal Reserve Bank of Atlanta Economic Review, Fourth Quarter, 1997. Nautz, D. (1995), Optimal bidding in multi-unit auctions with many bidders, Economic Letters 48, 301-306. Nautz, D. (1997), How auctions reveal information a case study on German repo rates, Journal of Money, Credit and Banking. Nautz, D. and E. Wolfstetter (1997), Bid shading and risk aversion in multi-unit auctions with many bidders", Economic Letters 56, 195-200. Scalia, A. (1997), Bidder Profitability under Uniform Price Auctions and Systematic Reopenings: The Case of Italian Treasury Bonds, Banco de Italia, No. 303, 1997. Umlauf, S. R. (1993), An empirical study of the Mexican Treasury bill auction, Journal of Financial Economics 33, 1993, 313-340. Uniform Price Auctions: Evaluation of the Treasury Experience, Department of the Treasury, U.S. Treasury, October 1995. Uniform Price Auctions: Update of the Treasury Experience, Department of theTreasury, U.S. Treasury, October 1998. Wang, J. D. and S. Vishwanathan (1996), Auctions with When-Issued Trading: A Model of the U.S. Treasury Markets, Duke University, Fuqua School of Business, Working Paper. Zheng, C. (2000), Optimal Auction with Resale, Northwestern University, Mimeograph, October 2000.

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