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Better Auctions and Better Products: A Presentation to the UK DMO

Julian D. A. Wiseman

Abstract: On 17th December 2008 the DMO published a wide-ranging consultation asking about other means of distributing gilts. Later that month this author sent Methods for Distributing Gilts: A Reply, after which the author was asked to present this reply at the DMO. The slides of this presentation, delivered Friday 6th February 2009, are available in PDF form, and in HTML below.

Publication history: presented on 6th February 2009 at the United Kingdom Debt Management Office, and then published at Usual disclaimer and copyright terms apply.

Contents: Slides; Auctionettes; Call options; Discussion.

Better Auctions
Better Products

Presented at the UK DMO
Friday 6th February 2009

The price is how ‘good’?

  • Hitherto, just before an auction, there has been a self-fulfilling belief that the market price is good in enough billions for an auction to clear near that price.

  • For German 10s, this belief has gone.

Germany: unsold proportion

‘Uncover’ ratios for recent German auctions

Chart showing ‘Amount set aside for secondary market operations’ ÷ ‘Issue volume’.

Observe that German 10s have fallen into a hole—and gilts might too.

Three Possibilities

  • There are only three possibilities:

    • Don’t fall in the hole (= proactive);

    • Climb out of the hole (= reactive);

    • Stay in the hole (= pessimal).

  • The Deutsche Finanzagentur is in the hole (= belief that prior market price won’t clear).

  • UK DMO can choose a better plan:

    • know that the hole beckons.

Failure of auction mechanism

  • Commentators: “too little demand”.

  • But if those Bunds had been for sale at a fixed price, say €90, there would have been plenty of demand.

  • Rather, the auction mechanism failed to find the price at which there was €6bn of demand.

Why failure to find price?

  • Auctions sell stuff, and provide information about the demand.

  • But that information, if available to bidders, helps them learn the price.

  • Gilt auction reveals that info too late.

  • Christies / Sothebys / Bonhams / etc use English auctions, as bids inform bidders. But wrong for divisible goods.

How fix?

  • So bidders should see some measure of demand before auction finished.

  • That entails splitting a £4bn auction, so that early pieces inform later bidding.

  • There are messy possibilities:

    • Tap £200mn every day for a month? Yuck.

    • Unpredictable discretionary taps? Yuck.

How to fix, as an auction?

  • Keeping the auction concept:

    • Split a £4bn auction into 40 ‘auctionettes’;

    • Hold auctionettes one minute apart;

    • Too fast for human intervention by seller:

      • must be totally automatic;

      • so there must be a minimum price;

    • Say, for a 10-year, min = £0.08 cheaper than clearing price of previous auctionette.

What to reveal about bids?

  • Don’t punish a lone bidder!

    • Don’t reveal total number of bids.

    • Don’t reveal total quantity of bids.

    • Don’t reveal gap average–clearing, hence each auctionette uniform price.

  • Be nice not nasty to a lone bidder (unlike current auction system).

What to reveal about bids?

  • About this auctionette:

    • The amount sold;

    • The uniform clearing price;

    • Prop’n of clearing-price bids filled = scaledown;

  • And about the next auctionette:

    • The minimum price;

    • And the (typically unchanged) amount for sale.

  • Not the number or quantity of bids, nor the average of their prices (whether of all or of accepted). Be nice to a lone bidder.

Soft pressure

  • Optionally, DMO could state that “Wholesale GEMMs are expected to bid for all of most auctionettes”.

  • That doesn’t punish if something dramatic happens, but sets an expectation.

A GEMM’s Strategy

  • Previous auctionette cleared at 100.50
    Next £100mn, minimum price 100.42.

  • Needs £5mn from each (£200mn total), and wants another £10mn from each (£400mn).

A GEMM’s Strategy

  • Optimal strategy? Something like:

    • Bid ≥101 for £5mn;

    • Bid 100.51 for £10mn;

    • Bid 100.49 for £25mn;

    • Bid 100.46 for £30mn;

    • Bid 100.43 for £30mn.

  • Even if only bidder, not a bad outcome. If others bid for only £50mn, clearing price 100.46, at which ≈£50mn bought. Also OK.

Details: Deemed Bids

  • n GEMMs; size of auctionette = £x;

  • Each GEMM not bidding for ≥x/n deemed to bid for deficit at min price;

  • Notate bene: NOT additional. Don’t punish a lone bidder! If a lone bidder bids for £10mn, that bidder bids for £10mn, not for £10mn+x/n.

Details: Minimum Price

  • Minimum price cannot rise by more than 1×DV01 at each auctionette:

    • A player or players might make a mistake, bidding far too high;

    • Restricting the maximum rise to the same 1×DV01 prevents, in the next auctionette, the deemed bids punishing the innocent by more than a trifle.

Details: Squeezes

  • Squeeze game: buy the bond at a price of fair+ε, becoming monopoly owner.

  • Impossible with auctionettes.

    • Squeezer buys first few auctionettes;

    • Other bidders respond, price rises;

    • Squeeze costs huge, ≥ monopoly profits.

  • But DMO might be redundantly cautious: could superimpose a y% rule.

Auctionettes: Q & A

‘Q’ first; ‘A’ second.

Selling calls on long gilts

  • Selling calls means the DMO sells gilts into a rising market;

  • Perfect zero-discretion transparency;

  • What Plenderleithian taps should be;

  • Balance-sheet efficient: £2 not £100;

  • Promote gilt rather than swap options;

  • High implied means HMT will be paid.

Details: Underlying

  • A gilt!

  • Conventional gilts with maturity much much longer than option expiry. So any gilt with ≥3 years to go;

  • As long gilts can and should be much larger, the 4¼ Dec 2055;.

  • ILGs later, or never.

Details: Expiry

  • Shorter gives more certainty about funding;

  • Options always outstanding (ideally several dates), so very short implies very high turnover;

  • Compromise: 28 day options:

    • Well-understood sort of horizon;

    • Weekly auctions ⇒ 4 sets outstanding.

Details: Strikes

  • Want to sell optionality, so strikes near the money;

  • Just ATM strikes would be acceptable;

  • But even split of 25%, 50% and 75% δs:

    • Slightly reduces variability of funding;

    • Ensures delta-hedgers stabilise market over good range of prices.

Details: Structure

  • OTC?

    • Not transferable.

  • ‘Gilt’ with pay-to-exchange rights?

    • At expiry DMO’s counterparty could be anybody, anything, or receiver thereof.

  • Listed pay-by-M2M option?

    • Best, but DMO will often be paying margin before receiving premium+strike.


  • Imagine that every week £500mn of each of 25%, 50% and 75% are sold.

  • Outstanding would be four series each of three strikes, totalling £6bn nominal. During a year £78bn, being an expected £39bn of funding + ≈£2bn of premium.

  • Given size of funding need, about right.

Options as Taps

  • Selling call options:

    • The transparent way to do ‘taps’;

    • Slightly market stabilising;

    • HMT should breakeven or better relative to sales of underlying;

    • A little uncertainty about achieved pace of funding, but with 28-day expiries, only little.

Options: Q & A

‘Q’ first; ‘A’ second.


In discussion it became clear that two matters had not been stated explicitly.

  1. If the DMO so desired, the first few auctionettes could be smaller than the standard size. For example, auctionettes could be £30mn for the first, £70mn for the second, and £100mn subsequently. However, this complexity ought to be redundant, as the £100mn was chosen to be a size in which a GEMM might ordinarily make a price. Also note that some care should be taken in drafting the rule that determines which auctionette(s) are shrunk by the size of the retail non-competitive allotment.

  2. Whilst a program of selling options on a particular gilt is happening, and hence there are options outstanding with that particular gilt as underlying, there can still be auction(ette)s of that gilt. Indeed, the fact that GEMMs own such options would be likely to improve demand—reduction in tail risk helping the bidders. Even a GEMM that doesn’t own any options would know that others do, and that their ownership reduces the likelihood of market misbehaviour.

— Julian D. A. Wiseman
New York, February 2009

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