The Risks of Safe Assets

70 Pages Posted: 13 Nov 2020 Last revised: 24 Jul 2021

See all articles by Yang Liu

Yang Liu

The University of Hong Kong - Faculty of Business and Economics

Lukas Schmid

University of Southern California - Marshall School of Business

Amir Yaron

University of Pennsylvania -- Wharton School of Business; Bank of Israel; National Bureau of Economic Research (NBER)

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Date Written: September 25, 2020

Abstract

How much safety and liquidity can the US government provide? Should it accommodate demand for these attributes because high convenience yields in Treasuries lower its borrowing cost? We evaluate a novel fiscal risk channel limiting the government's capacity to issue debt through the lens of a general equilibrium asset pricing model with a rich fiscal sector. Expanding safe asset supply lowers safety premia and improves liquidity in financial markets, but creates tax and consumption volatility, raising risk premia, credit spreads, and firms' cost of capital. Our model predicts that this risk channel leads to depressed growth prospects, rising Treasury yields, and elevated consumption risk, for which we find strong empirical evidence. We use our model to quantitatively evaluate current proposals on stimulus and stabilization packages and find that the risk channel is exacerbated in times of fiscal stress. Increasing safe asset supply can thus be risky, and have a significant fiscal cost.

Keywords: Government debt, safe assets, liquidity premium, uncertainty, growth, fiscal costs, risk premia, credit spreads, cost of capital, unconventional stabilization policies

Suggested Citation

Liu, Yang and Schmid, Lukas and Yaron, Amir and Yaron, Amir, The Risks of Safe Assets (September 25, 2020). Available at SSRN: https://ssrn.com/abstract=3699618 or http://dx.doi.org/10.2139/ssrn.3699618

Yang Liu

The University of Hong Kong - Faculty of Business and Economics ( email )

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Hong Kong
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Lukas Schmid (Contact Author)

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

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Amir Yaron

University of Pennsylvania -- Wharton School of Business ( email )

The Wharton School
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Bank of Israel

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National Bureau of Economic Research (NBER) ( email )

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