Pre-Auction Short Positions and Impacts on Primary Dealers' Bidding Behavior in US Treasury Auctions

We model the uniform-price US Treasury security auction as a static symmetric game of incomplete information in which each payer is a primary dealer who submits a demand schedule given two independent sources of private information – his pre-auction short position of the auctioned security, and his valuation of this security. Under the assumptions of constant marginal value and additive separability of his demand schedule, we obtain closed-form solutions for his optimal demand schedule, and we show how his pre-auction short position impacts his bidding behavior – in particular: the dealer's demand for the auctioned security increases with his pre-auction short position; the dealer's differential bid shading decreases with his pre-auction short position; and dealers with higher pre-auction short positions bid more aggressively, but assign lower values to the auctioned securities