research
2022
- Corporate Bond Elasticities: Substitutes MatterJian Li, Zhiyu Fu, and Manav Chaudhary2022
We construct exogenous demand shocks using quarterly mutual fund flow data to estimate CUSIP and portfolio elasticities for U.S. corporate bonds. Our approach relaxes the homogeneous cross-elasticity assumption implicitly embedded in many existing methods. At the CUSIP level, the elasticity is around 25, suggesting bonds are considerably more elastic than stocks. While individual bonds are highly elastic, aggregated portfolios of bonds are not—rating-level portfolio’s have elasticities as low as 0.2. Generally, demand elasticity is negatively related to the level of aggregation. We also find that demand is more elastic in the long run, with the price impact taking around three to four quarters to fully revert. Turning to heterogeneity in elasticities, we find high-yield and long-term bonds are more inelastic than investment-grade and short-term bonds. Furthermore, the sharp change in inelasticity around the IG/HY cut-off suggests that investor segmentation may be a source of demand inelasticity. Finally, we find difficult-to-replicate portfolios have more inelastic demand, consistent with greater arbitrage risk being a source of inelasticity. Overall, our findings contribute to understanding the key drivers of inelastic markets.
- The Convenience Yield, Inflation Expectations, and Public Debt Growth2022
U.S. long-term Treasury debt serves the important role of safe and liquid assets in the economy, hence carrying significant convenience yields. We present two new findings relating the convenience yield to inflation and government fiscal policy. First, the convenience yield of Treasury debt is negatively correlated with inflation expectations. Second, inflation expectations predict future debt-to-GDP growth at different horizons. To explain these findings, we incorporate convenience yields into a staggered-price model with a non-Ricardian fiscal policy. The convenience yield for long-term debt is the discounted value of future convenience service flows, thus negatively correlated with future debt supply. Furthermore, a government deficit shock leads to both higher debt in the future as well as higher expected inflation simultaneously. The model rationalizes the two empirical findings and provides a natural framework to study the interactions among inflation, debt growth, and cost of borrowing, particularly the convenience yield component.
- Risk-Based Regulations in Credit Markets: A Heterogeneous Risk AcceleratorZhiyu Fu2022
Credit markets in the U.S. are dominated by institutional investors, whose risk capacity is limited by various risk-based regulations. I study the macroeconomic implications of such risk-based regulations in a general-equilibrium model featuring firms with heterogeneous credit risks and a bond investor subject to risk-based constraints. During economic downturns, these risk-based constraints become a heterogeneous risk accelerator: It increases the debt financing cost for risky firms, amplifying their default risk, while generating convenience yields for the safest firms. In aggregate, these constraints significantly amplify the drop in investment and output. I evaluate the effects of credit market intervention programs using this framework. I find that during credit market disruptions, credit facilities mitigate the initial damage and speed up the follow-up recovery.