US Government Debt Different - Finance Department - University of ...

14 A World Without Treasuries?able, that the entire public Treasury stock could disappear in five orten years. Actors in the government and in financial markets focusedclosely on the expected costs of a treasury-less world. Their projectionsbear on the present discussion.Treasuries in Asset PricingLet us look first at asset pricing. Recall that under the capital assetpricing model, the expected return on an asset equals the risk freerate of return plus the return on the market times a volatility factorcalled beta. The model is theoretically parsimonious but surprisinglyindeterminate as regards real world application. Most of the discussiongoes to the robustness of beta as a risk measure. Let us put thatto one side and go to the easier parts of the model. There are problemseven there. The return on the market is a past return and socan be derived empirically. But there is no generally accepted calculus.Some use a geometric average, others use an arithmetic average.Terms of years also vary. Most use a 30 year past period, but othersuse shorter terms.Current Treasury rates fill in the risk free return component. Butthere is variance in the practice even here. Most use a current shortterm bill rate. But some use a 30 year bond. Some use a blended rateof bills, notes, and bonds. Depending on yields, the choice amongbills, notes, and bonds could mean a 100 or 200 basis point differencein a discount rate, and a huge difference at the bottom line of areal world valuation.The point is that Treasuries’ place in asset pricing is not quite as clearcut as first appears, even assuming that Treasuries really are risk free,which of course they are not. Once we fold in inflation and rate risk,Treasuries emerge as the most workable proxy for a risk free rate. Ifone adds liquidity risk and extraordinary conditions, they becomeproblematic. That is one of the reasons why stories from the period1998 to 2000 are interesting.Economists who confronted the question as to what would happenif budget surpluses caused Treasuries to disappear answered that we