Liquidity Premium and the Substitution Between Money and Treasuries

Posted: 11 Sep 2018 Last revised: 3 Jul 2021

See all articles by Wenhao Li

Wenhao Li

University of Southern California - Marshall School of Business

Date Written: December 4, 2020

Abstract

This paper quantifies the substitution between money (bank deposits) and Treasuries. The estimation is significantly different from either zero or perfect substitution. Thus, fixing monetary policy, Treasury supply still affects the liquidity premium. Furthermore, the substitution increases over time. Regressions that miss the economic interactions between quantities and rates are inconclusive, while structural estimations provide superior statistical power. My estimation implies new channels of Treasury supply on the real economy and foreign exchange rates. Furthermore, it helps resolve the government debt valuation puzzle. I also discuss how my findings relate to Nagel (2016).

Keywords: liquidity premium; substitution; Treasury supply; money; debt valuation

JEL Classification: E41, E44, E63, G12

Suggested Citation

Li, Wenhao, Liquidity Premium and the Substitution Between Money and Treasuries (December 4, 2020). USC Marshall School of Business Research Paper, Available at SSRN: https://ssrn.com/abstract=3239293 or http://dx.doi.org/10.2139/ssrn.3239293

Wenhao Li (Contact Author)

University of Southern California - Marshall School of Business ( email )

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