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Journal of Financial Economics Vol. 143 No. 1 2022

Treasury inconvenience yields during the COVID-19 crisis

Zhiguo He1,2,3; Stefan Nagel1,4,2,5; Zhaogang Song6,7

1 National Bureau of Economic Research · 2 University of Chicago · 3 Stanford University · 4 Ifo Institute for Economic Research · 5 Centre for Economic Policy Research · 6 Johns Hopkins University · 7 William Carey University

open access

Abstract

In sharp contrast to most previous crisis episodes, the Treasury market experienced severe stress and illiquidity during the COVID-19 crisis, raising concerns that the safe-haven status of US Treasuries may be eroding. We document large shifts in Treasury ownership and temporary accumulation of Treasury and reverse repo positions on dealer balance sheets during this period. We build a dynamic equilibrium asset pricing model in which dealers subject to regulatory balance sheet constraints intermediate demand/supply shocks from habitat agents and provide repo financing to levered investors. The model predicts that Treasury inconvenience yields, measured as the spread between Treasuries and overnight-index swap rates (OIS), as well as spreads between dealers’ reverse repo and repo rates, should be highly positive during the COVID-19 crisis, as is confirmed in the data. The same model framework, adapted to the institutional setting in 2007–2009, can also explain the negative Treasury-OIS spread observed during the Great Recession.

DOI
10.1016/j.jfineco.2021.05.044
Volume
143
Issue
1
Pages
57-79
Language
en
Sources
bibtex:phds-export.bib openalex crossref

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