U.S. Risk and Treasury Convenience

Abstract

We document a rise in investors' assessment of U.S. risk relative to other G.7 economies since the late 1990s, driven by higher permanent risk but not reflected in currency returns. Using a two-country framework with trade in a rich maturity structure of bonds which earn convenience yields, alongside risky assets and currencies, we establish an equilibrium relationship between cross-border convenience yields, relative country risk and carry-trade returns. Empirically, we identify a cointegrating relationship between relative permanent risk and long-maturity convenience yields. Counterfactual experiments show rising relative permanent risk explains around one-third of declining long-maturity convenience yields over 2002-2006 and 2010-2014.