Identifying the Effects of Demand for Safe Assets

74 Pages Posted: 12 Feb 2024

See all articles by Jefferson Duarte

Jefferson Duarte

Rice University - Jesse H. Jones Graduate School of Business

Tarik Umar

Rice University

Date Written: January 29, 2024

Abstract

Limits to arbitrage along with the high demand for safe assets may explain both low long-term interest rates (the Greenspan conundrum) and record levels of securitization before the 2007-2008 crisis. To identify this mechanism, we capitalize on the suspension of 30-year Treasury bond auctions in 2002. Revealing limits to arbitrage, the announcement sharply increased the prices of Treasury bonds, foreign long-term sovereign bonds, as well as the prices and creation of long-term safe collaterilized-mortgage obligations (CMOs). Investors demanding safe long-term bonds (life insurers) switched from Treasury bonds to CMO substitutes. Heterogeneity in Treasuries and CMOs allows for unusually clean identification.

Keywords: Limits to arbitrage, safe assets, preferred habitat, securitization, tranching, financial crisis

JEL Classification: E41, E44, E51, E58, G11, G22, G23

Suggested Citation

Duarte, Jefferson and Umar, Tarik, Identifying the Effects of Demand for Safe Assets (January 29, 2024). Available at SSRN: https://ssrn.com/abstract=4708921 or http://dx.doi.org/10.2139/ssrn.4708921

Jefferson Duarte (Contact Author)

Rice University - Jesse H. Jones Graduate School of Business ( email )

6100 South Main Street
P.O. Box 1892
Houston, TX 77005-1892
United States
713.3486137 (Phone)

HOME PAGE: http://www.jefferson-duarte.com/

Tarik Umar

Rice University ( email )

Houston, TX
United States

HOME PAGE: http://https://business.rice.edu/person/tarik-umar

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