C-STRIPS AND P-STRIPS
- Thread starter notjusttp
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There are a few threads on the forum about this trade rich/cheap in Tuckman; e.g., http://forum.bionicturtle.com/viewthread/675/#1562
Tuckman in Ch 15 gives a hint (in another context): "Recent issues tend to trade at higher prices than otherwise similar issues. Some of this premium is due to the demand for shorts and the resulting financing advantage, that is, the ability to borrow money at less than GC rates when using these bonds as collateral. Any additional premium, which might be called a pure liquidity premium, is due to the liquidity demands from long positions. Market participants often refer to the sum of the financing advantage and the pure liquidity premium—that is, to the entire premium of a recent issue relative to an otherwise similar issue—as the liquidity premium. "
In short, Tuckman attributes trade rich/cheap to liquidity and/or supply/demand (i.e., high demand bids up price and creates "trade rich"; low liquidity implies trade cheap).
Here is my opinion of these points by Tuckman:
* They are about temporal observed prices versus model prices. Hence, there is no "logic" in the model but would need to be discerned from an understanding of market participants
* If market participants change their habits, these observations can change or be reversed
* The teaching point, to my thinking is: trading rich/cheap is proof of the existence of model risk! It proves our model does not incorporate all of the factors that influence price. If our model were perfect, we would never observe market prices <> model prices.
* The distinction i like: our model includes fundamental factors factors (i.e., can be contractually compensated) but, generally, does not include technical factors (supply/demand, maybe liquidity)
David
Tuckman in Ch 15 gives a hint (in another context): "Recent issues tend to trade at higher prices than otherwise similar issues. Some of this premium is due to the demand for shorts and the resulting financing advantage, that is, the ability to borrow money at less than GC rates when using these bonds as collateral. Any additional premium, which might be called a pure liquidity premium, is due to the liquidity demands from long positions. Market participants often refer to the sum of the financing advantage and the pure liquidity premium—that is, to the entire premium of a recent issue relative to an otherwise similar issue—as the liquidity premium. "
In short, Tuckman attributes trade rich/cheap to liquidity and/or supply/demand (i.e., high demand bids up price and creates "trade rich"; low liquidity implies trade cheap).
Here is my opinion of these points by Tuckman:
* They are about temporal observed prices versus model prices. Hence, there is no "logic" in the model but would need to be discerned from an understanding of market participants
* If market participants change their habits, these observations can change or be reversed
* The teaching point, to my thinking is: trading rich/cheap is proof of the existence of model risk! It proves our model does not incorporate all of the factors that influence price. If our model were perfect, we would never observe market prices <> model prices.
* The distinction i like: our model includes fundamental factors factors (i.e., can be contractually compensated) but, generally, does not include technical factors (supply/demand, maybe liquidity)
David
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