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Working Paper
A Probability-Based Stress Test of Federal Reserve Assets and Income
To support the economy, the Federal Reserve amassed a large portfolio of long-term bonds. We assess the Fed?s associated interest rate risk ? including potential losses to its Treasury securities holdings and declines in remittances to the Treasury. Unlike past examinations of this interest rate risk, we attach probabilities to alternative interest rate scenarios. These probabilities are obtained from a dynamic term structure model that respects the zero lower bound on yields. The resulting probability-based stress test finds that the Fed?s losses are unlikely to be large and remittances are ...
Journal Article
Have the Fed liquidity facilities had an effect on Libor?
In response to turmoil in the interbank lending market, the Federal Reserve inaugurated programs to bolster liquidity beginning in December 2007. Research offers evidence that these liquidity facilities have helped lower the London interbank offered rate, a key market benchmark, significantly from what it otherwise would have been expected to be.
Working Paper
International Evidence on Extending Sovereign Debt Maturities
Portfolio diversification is as important to debt management as it is to asset management. In this paper, we focus on diversification of sovereign debt issuance by examining the extension of the maximum maturity of issued debt. In particular, we examine the potential costs to the U.S. Treasury of introducing 50-year bonds as a financing option. Based on evidence from foreign government bond markets with such long-term debt, our results suggest that a 50-year Treasury bond would likely trade at an average yield that is at most 20 basis points above that of a 30-year bond. Our results based on ...
Working Paper
A Regime-Switching Model of the Yield Curve at the Zero Bound
This paper presents a regime-switching model of the yield curve with two states: a normal state and a zero-bound state for the case when the monetary policy target rate is stuck at the nominal zero bound, as the U.S. economy has been since December 2008. The model delivers estimates of the time-varying probability of exiting the zero-bound state and can be applied to generate outcome-contingent forecasts useful for portfolio stress tests. The results show that the probability of remaining in the zero-bound state has trended upward since 2009, with notable upticks following Federal Reserve ...
Journal Article
What Would It Cost to Issue 50-year Treasury Bonds?
The longest-term U.S. Treasury bonds that investors can buy mature in 30 years. Some other countries offer up to 50-year government bonds. Examining these foreign bond markets and extrapolating U.S. Treasury yields to evaluate such longer-term options suggests that the extra costs of introducing 50-year bonds relative to conventional 30-year bonds are likely to be small on average. Because the U.S. fiscal deficit remains substantial, such longer-term debt instruments could provide an attractive opportunity to finance the growing debt in a sustainable way.
Journal Article
Emerging Bond Markets and COVID-19: Evidence from Mexico
The pandemic caused by the coronavirus is depressing economic activity and severely straining government budgets globally. Without international support, the ability of emerging economies to weather this crisis will depend crucially on access to and the cost of borrowing in domestic government bond markets. Analyzing bond flows and risk premiums for Mexican government bonds during the pandemic gives some insights into a major emerging economy’s experience. Mexican risk premiums have increased more than 1 percentage point above predicted levels, pointing to tighter funding conditions for the ...
Working Paper
The Safety Premium of Safe Assets
Safe assets usually trade at a premium due to their high credit quality and deep liquidity. To understand the role of credit quality for such premia, we focus on Swiss Confederation bonds, which are extremely safe but not particularly liquid. We therefore refer to their premia as safety premia and quantify them using an arbitrage-free term structure model that accounts for time-varying premia in individual bond prices. The estimation results show that Swiss safety premia are large and exhibit long-lasting trends. Furthermore, our regression analysis suggests that they shifted upwards ...
Journal Article
Exploring the Safety Premium of Safe Assets
Investors are usually willing to pay a higher price, known as a premium, for a safe fixed-income asset in return for the convenience of its high quality and liquidity. A study of Swiss government bonds—widely considered to be extremely safe but not particularly liquid—can give some insights into how quality affects the premium. The large and variable safety premium of these bonds surged to persistently higher levels following the launch of the euro. However, subsequent large asset purchases by the European Central Bank depressed the safety premium.
Working Paper
Quantitative Easing, Bond Risk Premia and the Exchange Rate in a Small Open Economy
We assess the impact of simultaneous large-scale asset purchases, commonly known as quantitative easing (QE), conducted by Sveriges Riksbank and the European Central Bank (ECB) on bond risk premia in the Swedish government bond market. Using a novel arbitrage-free dynamic term structure model of nominal and real bond prices that accounts for bond-specific safety premia, we find that Sveriges Riksbank’s bond purchases raised inflation and short-rate expectations, lowered nominal and real term premia and inflation risk premia, and increased nominal bond safety premia, suggestive of signaling, ...
Working Paper
Modeling Yields at the Zero Lower Bound: Are Shadow Rates the Solution?
Recent U.S. Treasury yields have been constrained to some extent by the zero lower bound (ZLB) on nominal interest rates. In modeling these yields, we compare the performance of a standard affine Gaussian dynamic term structure model (DTSM), which ignores the ZLB, and a shadow-rate DTSM, which respects the ZLB. We find that the standard affine model is likely to exhibit declines in fit and forecast performance with very low interest rates. In contrast, the shadow-rate model mitigates ZLB problems significantly and we document superior performance for this model class in the most recent period.