Abstract

Treasury bond yields are affected by credit and liquidity. This paper determines the extent to which Treasury bond holders are concerned about liquidity and quality during times of market distress. Using data from the American sovereign bonds market, we find that investors increasingly demand liquidity whereas credit quality continues to be an important determinant of Treasury bond yields when the market is not favorable. Specifically, credit quality accounts for the majority of the variation in bond yields while liquidity plays a substantially smaller role during times of financial crisis. Furthermore, credit quality has a larger and stronger effect on bonds with a longer time to maturity, suggesting that changes in credit quality are a long-term concern that may be associated with changes in fiscal discipline and political policy.