Hansen-Jagannathan Bounds with Convenience Yields
21 Pages Posted:
Date Written: January 12, 2022
Short-term Treasury debt has high Sharpe ratios and, according to the Hansen-Jagannathan bound, implies a very volatile bond market SDF. In this paper, we show that a small convenience yield on the risk-free asset can rationalize this pattern without requiring a volatile SDF. We further show that, in the presence of convenience yields, the Hansen-Jagannathan bound needs to be generalized as a two-dimensional trade-off between SDF volatility and the convenience yield. We quantify this trade-off in the context of the Treasury market and evaluate the implication of these empirical results for SDF bounds. Assets with low return volatility have Sharpe ratios that are most impacted by convenience yields.
Keywords: Bond Returns, Convenience Yields, Sharpe Ratios, Hansen-Jagannathan Bound
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