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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.

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up vote 7 down vote accepted

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

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Great! Thank you so much. – Anonymous Dec 11 '13 at 17:55

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