Treasury Inconvenience Yields During the Covid-19 Crisis

62 Pages Posted: 23 Jun 2020

See all articles by Zhiguo He

Zhiguo He

Stanford University - Knight Management Center

Stefan Nagel

University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER); Centre for Economic Policy Research; CESifo (Center for Economic Studies and Ifo Institute)

Zhaogang Song

Johns Hopkins University - Carey Business School

Multiple version iconThere are 2 versions of this paper

Date Written: June 15, 2020

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 U.S. Treasuries may be eroding. We document large shifts in Treasury ownership during this period and the accumulation of Treasury and reverse repo positions on dealer balance sheets. To understand the pricing consequences, we build a model in which balance sheet constraints of dealers and demand/supply shocks from habitat agents determine the term structure of Treasury yields. A novel element of our model is the inclusion of levered investors’ repo financing as part of dealers’ intermediation activities. Both direct holdings of Treasuries and reverse repo positions of dealers are subject to a regulatory balance sheet constraint. According to the model, Treasury inconvenience yields, measured as the spread between Treasuries and overnight-index swap (OIS) rates, as well as spreads between dealers’ reverse repo and repo rates, should be increasing in dealers’ balance sheet costs. Consistent with model predictions, we find that both spreads are large and positive during the COVID-19 crisis. We further show that the same model, adapted to the institutional setting in 2007-2009, also helps explain the opposite signs of repo spreads and Treasury convenience yields during the financial crisis.

Keywords: D8, G2

JEL Classification: Repo, safe asset, Treasury, habitat, dealer, yield curve

Suggested Citation

He, Zhiguo and Nagel, Stefan and Song, Zhaogang, Treasury Inconvenience Yields During the Covid-19 Crisis (June 15, 2020). University of Chicago, Becker Friedman Institute for Economics Working Paper No. 2020-79, Available at SSRN: https://ssrn.com/abstract=3631139 or http://dx.doi.org/10.2139/ssrn.3631139

Zhiguo He (Contact Author)

Stanford University - Knight Management Center ( email )

655 Knight Way
Stanford, CA 94305-7298
United States

Stefan Nagel

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research ( email )

London
United Kingdom

CESifo (Center for Economic Studies and Ifo Institute) ( email )

Poschinger Str. 5
Munich, DE-81679
Germany

Zhaogang Song

Johns Hopkins University - Carey Business School ( email )

100 International Drive
Baltimore, MD 21202
United States

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