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Wenhao Li joined the Department of Finance and Business Economics in 2019. His research interests include financial intermediation, asset pricing, and macroeconmics.
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INSIGHT + ANALYSIS
Article: Understanding the "Inconvenience" of U.S. Treasury Bonds
WENHAO LI, assistant professor of finance and business economics, co-authored a piece looking at "inconvenient" Treasury bonds and the role dealers' balance sheet constraints in explaining it for NEWYORKFED.ORG.
RESEARCH + PUBLICATIONS
We analyze the term structure of Treasury liquidity premium (LP). Through a model
where illiquidity shocks are alleviated by holding Treasuries, we show that LP term
structure is shaped by expectations of future market liquidity, liquidity term premium, and Treasury supply. As predicted, the LP term structure is downward-sloping
in recessions but upward-sloping in booms, and forward LP predicts future LP and
market liquidity. Furthermore, LP is quantitatively important for monetary policy
pass-through: LP dampens the pass-through of interest rate policy yet strengthens
the pass-through of quantitative easings. We also use LP to infer the term structure
of Treasury safety premium.
We develop a model of financial crises with both a financial amplification mechanism, via frictional intermediation, and a role for sentiment, via time-varying beliefs about an illiquidity state. We confront the model with data on credit spreads, equity prices, credit, and output across the financial crisis cycle. In particular, we ask the model to match data on the frothy pre-crisis behavior of asset markets and credit, the sharp transition to a crisis where asset values fall, disintermediation occurs and output falls, and the post-crisis period characterized by a slow recovery in output. A pure amplification mechanism quantitatively matches the crisis and aftermath period but fails to match the pre-crisis evidence. Mixing sentiment and amplification allows the model to additionally match the pre-crisis evidence. We consider two versions of sentiment, a Bayesian belief updating process and one that overweighs recent observations. Both models match the crisis patterns qualitatively, while the non-Bayesian model better matches the pre-crisis froth quantitatively. Finally, we show that a lean-against-the-wind policy has a quantitatively similar impact in both versions of the belief model, indicating that policy need not condition on true beliefs.