"Can U.S. Treasury Markets Add and Subtract?"

Abstract:The daily releases by the CBO of cost projections for individual U.S. spending and tax bills contain valuable news about primary surpluses that are priced in by U.S. Treasury markets. In a daily event window, news of lower future surpluses that is extracted from these projections decreases the realized nominal return on the portfolio of Treasurys. The expected return on government debt increases as the convenience yields decrease and the term premia increases. The effect on realized and expected returns increases even after the initial news release. Using a present value framework, we account for the bond return response and its subsequent drift in a model with Bayesian investors who use the cost releases to learn about the evolution of the surplus process.

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