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Nominal U.S. Treasuries Embed Liquidity Premiums, Too

Published online by Cambridge University Press:  06 November 2023

J. Benson Durham Open the ORCID record for J. Benson Durham [Opens in a new window]
J. Benson Durham*
Affiliation:
Piper Sandler; School of International and Public Affairs, Columbia University; Department of Economics, NYU
*
jbd4@columbia.edu
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Abstract

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A novel arbitrage-free model of nominal U.S. Treasuries that decomposes yields into frictionless expected rates, frictionless term premiums, and liquidity premiums produces four key results from Jan. 1987 to Aug. 2023. First, liquidity loadings are larger than for the slope and higher-order principal components. Second, the countercyclicality of required nominal Treasury returns owes to liquidity, if anything, not frictionless term premiums. Third, Federal Reserve large-scale asset purchases generally work through expected rates and frictionless term premiums, not liquidity premiums. Fourth, given similar estimates using TIPS, inflation expectations are less moored around the Federal Reserve’s price objectives than other models say.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , First View , pp. 1 - 32
Creative Commons
Creative Common License - CCCreative Common License - BY
This is an Open Access article, distributed under the terms of the Creative Commons Attribution licence (http://creativecommons.org/licenses/by/4.0), which permits unrestricted re-use, distribution and reproduction, provided the original article is properly cited.
Copyright
© The Author(s), 2023. Published by Cambridge University Press on behalf of the Michael G. Foster School of Business, University of Washington

Footnotes

Without implication, the author thanks an anonymous referee and Tobias Adrian for helpful comments.

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