Convenience Yields in Euros: Investment Mandates and Conditional QE

Abstract

I document novel puzzles in convenience yields in euros: when governments borrow through entities that are not formally sovereigns (such as supranationals) they all pay a common interest rate regardless of default risk or liquidity. This rate is significantly higher than for sovereign debt and more exposed to expectations about monetary policy. I develop a model consistent with these facts by exploring the role of investment mandates that reduce the size of potential investors in supranationals relative to equally safe governments. The smaller size of potential buyers translates into lower expected liquidity during crises such that even risk-neutral investors require a premium to hold supranationals. Expectations about asset purchases during crises, which I call conditional QE, can significantly compress this premium even if they are not targeted.

Keywords: Convenience yields, Investment mandates, QE, Supranational bonds, Sovereign bonds, European Union

JEL Classification: E52, E58, F36, F45, G23, H63