Treasury Debt and Corporate Bond Rates
Skip to content
Podcast | Insight Unpacked Season 1: Extraordinary Brands and How to Build Them
Policy Finance & Accounting Nov 1, 2007

Treasury Debt and Corporate Bond Rates

The bond yield spread reflects a Treasury debt convenience yield for investors

Based on the research of

Arvind Krishnamurthy

Annette Vissing-Jørgensen

Listening: Interview with Arvind Krishnamurthy
0:00 Skip back button Play Skip forward button 16:11

In “The Demand for Treasury Debt,” Kellogg School of Management professors Arvind Krishnamurthy and Annette Vissing-Jørgensen relate the yield spread between AAA-rated corporate bonds and Treasury securities to the U.S. government debt-to-GDP ratio—that is, the ratio of the face value of publicly held U.S. government debt to U.S. gross domestic product (GDP). They find that the corporate bond spread is high when the stock of government debt is low while the spread is low when the stock of debt is high.

Figure 1: Corporate Bond Spread and Government Debt

The researchers believe that this negative correlation between the debt-to-GDP ratio and the corporate bond spread occurs because of variation in the “convenience yield” on Treasury securities. Investors value Treasury securities—which have convenience value—beyond the securities’ cash flows. When the stock of debt is low, the marginal convenience valuation of debt is high. Investors bid up the price of Treasuries relative to other securities, such as corporate bonds, causing the yield on Treasuries to fall further below corporate bond rate. This situation leads the bond spread to widen. The opposite applies when the stock of debt is high.

What are the sources of this convenience yield on Treasury securities? Studying disaggregated data from the Federal Reserve’s Flow of Funds Accounts, Krishnamurthy and Vissing-Jørgensen maintain that different groups of Treasury owners likely have different reasons for holding Treasuries. The three chief reasons are as follows: 1) the high liquidity of Treasuries compared to corporate bonds; 2) neutrality, which may motivate official institutions such as U.S. Federal Reserve banks, state and local governments, and foreign central banks to hold Treasuries to avoid favoring any non-governmental borrower over another; and 3) Treasuries’ widespread reputation as the lowest-risk interest-bearing asset.

The researchers then examine which groups of investors are the strongest drivers of the convenience value of Treasury securities. They find that Treasury demands of official institutions are the least sensitive to the corporate bond spread while demands of long-horizon investors—such as pension plans and insurance companies—are more sensitive. Finally, they present implications of their findings for corporate bond spreads, the financing of the U.S. deficit, the riskless interest rate, and the value of aggregate liquidity.

Among their conclusions, Krishnamurthy and Vissing-Jørgensen note that investors value Treasuries, despite their relative low return, for their liquidity and convenience. They estimate that at the current level of Treasury debt-to-GDP, the convenience yield on the Treasury debt is around 0.7 percentage points. This, in turn, means that taxpayers benefit from being able to finance the federal debt with securities that have special benefits to investors. The implied saving is around 0.3 percent of GDP per year. In fact, the annual interest expense to taxpayers from being able to finance the current level of debt with securities that have a convenience yield is about as large as the annual benefit to taxpayers resulting from the public’s willingness to hold money at no interest.

Another implication of the results is that if foreign official investors decide to quit the U.S. Treasury market (thus selling roughly 29 percent of the debt back to U.S. investors), this sell-off would raise Treasury yields relative to corporate bond yields. The researchers estimate this effect at 0.3 percentage points. In addition, long-term investors who are seeking to build retirement funds and who do not place much value on the liquidity of Treasuries would be better off investing in AAA corporate bonds rather than Treasury bonds.

Furthermore, the finding of a convenience demand for Treasury debt suggests caution against the common practice of identifying the Treasury interest rate with asset pricing models’ riskless interest rate. This has practical implications, for example, for companies estimating their cost of capital.

Krishnamurthy and Vissing-Jørgensen summarize their findings by noting that they have shown that the demand for “convenience” provided by Treasury debt depends on the yield spread, and they provide estimates of the elasticity of demand. A hypothetical rise in the debt-to-GDP ratio from its current value of 0.38 to a new value of 0.39 will decrease the spread between corporate bond yields and Treasury bond yields between 1.5 basis points (0.015 percentage points) and 4.25 basis points. Individual groups of Treasury holders have downward sloping demand curves. Even groups with the most elastic demand curves have demand curves that are far from flat. “Our results,” the analysts say, “suggest that U.S. government debt is a special asset that offers a convenience yield to investors. Our estimates imply that the value of the liquidity provided by the current level of Treasuries is between 0.21 and 0.54 percent of GDP per year.”

About the Writer
Matt Nesvisky, is a freelance writer. Reproduced with permission from The NBER Digest (National Bureau of Economic Research), August 2007.
About the Research

Krishnamurthy, Arvind and Annette Vissing-Jørgensen (2007). “The Demand for Treasury Debt,” NBER Working Paper No. 12881.

Read the original

Most Popular This Week
  1. Your Team Doesn’t Need You to Be the Hero
    Too many leaders instinctively try to fix a crisis themselves. A U.S. Army colonel explains how to curb this tendency in yourself and allow your teams to flourish.
    person with red cape trying to put out fire while firefighters stand by.
  2. How Experts Make Complex Decisions
    By studying 200 million chess moves, researchers shed light on what gives players an advantage—and what trips them up.
    two people playing chess
  3. What Went Wrong with FTX—and What’s Next for Crypto?
    One key issue will be introducing regulation without strangling innovation, a fintech expert explains.
    stock trader surrounded by computer monitors
  4. What Triggers a Career Hot Streak?
    New research reveals a recipe for success.
    Collage of sculptor's work culminating in Artist of the Year recognition
  5. How Much Do Campaign Ads Matter?
    Tone is key, according to new research, which found that a change in TV ad strategy could have altered the results of the 2000 presidential election.
    Political advertisements on television next to polling place
  6. What’s the Secret to Successful Innovation?
    Hint: it’s not the product itself.
    standing woman speaking with man seated on stool
  7. Which Form of Government Is Best?
    Democracies may not outlast dictatorships, but they adapt better.
    Is democracy the best form of government?
  8. Immigrants to the U.S. Create More Jobs than They Take
    A new study finds that immigrants are far more likely to found companies—both large and small—than native-born Americans.
    Immigrant CEO welcomes new hires
  9. How Are Black–White Biracial People Perceived in Terms of Race?
    Understanding the answer—and why black and white Americans may percieve biracial people differently—is increasingly important in a multiracial society.
    How are biracial people perceived in terms of race
  10. Yes, Consumers Care if Your Product Is Ethical
    New research shows that morality matters—but it’s in the eye of the beholder.
    woman chooses organic lettuce in grocery
  11. What Donors Need to Hear to Open the Checkbook
    Insights from marketing on how charities can grow by appealing to different kinds of donors.
  12. Why Well-Meaning NGOs Sometimes Do More Harm than Good
    Studies of aid groups in Ghana and Uganda show why it’s so important to coordinate with local governments and institutions.
    To succeed, foreign aid and health programs need buy-in and coordination with local partners.
  13. What Went Wrong at AIG?
    Unpacking the insurance giant's collapse during the 2008 financial crisis.
    What went wrong during the AIG financial crisis?
  14. The Complicated Logic Behind Donating to a Food Pantry Rather than Giving a Hungry Person Cash
    If we were in need, we’d likely want money. So what accounts for that difference?
    Donating food is paternalistic aid
  15. Product Q&A Forums Hold a Lot of Promise. Here’s How to Make Them Work.
    The key to these online communities, where users can ask and answer questions, is how many questions get useful answers.
    man sits at computer reading Q&A forum
  16. Podcast: What the FTX Meltdown Means for the Future of Crypto
    The implosion of the crypto exchange has sent the industry reeling. We dig into what happened and whether cryptocurrency, as a concept, can weather the storm.
  17. What the New Climate Bill Means for the U.S.—and the World
    The Inflation Reduction Act won’t reverse inflation or halt climate change, but it's still a big deal.
    energy bill with solar panels wind turbines and pipelines
  18. To Improve Fundraising, Give Donors a Local Connection
    Research offers concrete strategies for appealing to donors who want to make an impact.
    Charity appeals that frame the message around local connection tend to be more successful as a result of the proximity effect
  19. Post-War Reconstruction Is a Good Investment
    Ukraine’s European neighbors will need to make a major financial commitment to help rebuild its economy after the war. Fortunately, as the legacy of the post–World War II Marshall Plan shows, investing in Ukraine's future will also serve Europe's own long-term interests.
    two people look out over a city
More in Policy