The Liquidity Premium of Near-Money Assets
Treasury bills and other near-money assets provide owners with liquidity service benefits that are reflected in prices in the form of a liquidity premium. I relate time variation in this liquidity premium to changes in the opportunity cost of money: The liquidity service benefits of near-money assets are more valuable when short-term interest rates are high and hence the opportunity cost of holding money is high. Consistent with this prediction, the liquidity premium of T-bills and other near-money assets is strongly positively correlated with the level of short-term interest rates. Once short-term interest rates are controlled for, Treasury security supply variables lose their explanatory power for the liquidity premium. I argue that an analysis of scarcity and price of near-money assets is incomplete without taking into account the substitution relationship with money and its supply by the central bank. Payment of interest on reserves (IOR) could potentially reduce liquidity premia because IOR reduces the opportunity cost of at least one type of money (reserves). In the UK and Canada, however, the introduction of IOR did not shrink liquidity premia. Apparently, the reduction in banks' opportunity cost of money did not result in a broader fall in the opportunity costs of money for non-bank market participants.
I am grateful for comments to Arvind Krishnamurthy, Francis Longstaff, Paolo Pasquariello, Jose-Luis Peydro, seminar participants at HEC Paris, Michigan, Stanford, Toulouse and participants at the American Economic Association Meetings and the LBS Safe Assets Conference. Mike Schwert and Yesol Huh provided excellent research assistance. I thank Henning Bohn, Daniel Hanson, Allan Mendelowitz, and Paolo Pasquariello for providing data. The views expressed herein are those of the author and do not necessarily reflect the views of the National Bureau of Economic Research.
Stefan Nagel, 2016. "The Liquidity Premium of Near-Money Assets," The Quarterly Journal of Economics, Oxford University Press, vol. 131(4), pages 1927-1971. citation courtesy of