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The Incredible Upside-Down Fixed-Income Market: Negative Interest Rates and Their Implications

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The Incredible Upside-Down Fixed-Income Market: Negative Interest Rates and Their Implications

In recorded financial history, there are almost no occasions, other than the present, where a significant portion of the global bond markets has been trading at negative nominal yields. Is this an anomaly or what will be the normal state of the financial markets in years to come?

This monograph investigates the ongoing debate between the pros and cons of negative nominal yields and the economic rationale(s) that are used to justify or criticize underlying policies. Even in academic circles, few agree on the costs and benefits of negative yields.

Surveying the global bond markets of the day, I find the impact of negative yields in almost all regions and sectors, though sovereign bond markets, which are closest to monetary policy, are the dominant category of bonds with negative yields.

I next look at the participants in the negatively yielding bond market and at the motivations that justify their actions. The conclusion is that although different participants might have different reasons to buy negatively yielding bonds, their collective action is certainly responsible for creating a local equilibrium in which these markets clear.

Central bank policy is the next focus in this monograph, and I discuss in depth the economic rationale as propounded by one such bank, the European Central Bank. I conclude with a discussion of the blurring lines between monetary and fiscal policy, which are likely to become centerpieces in future years as global sovereign debt levels rise.

Next, I look at the influence of negative yields on other asset markets, such as equities, and especially derivatives markets, such as the demand for options. A discussion of potential risks then follows. The monograph concludes with a review of the impact of negative yields on nonfinancial aspects of society.

Although the forecast is anything but crystal clear, the evolution of markets and economics in the years to come will undoubtedly be influenced by this massive economic experiment of negative yields.

About the Author

Vineer Bhansali

Vineer Bhansali is the founder and chief investment officer of LongTail Alpha, LLC. His 29-year investment career started at Citibank, where he founded and managed the Exotic and Hybrid Options Trading Desk. He later joined Salomon Brothers in its Fixed Income Arbitrage Group followed by Credit Suisse First Boston in its Proprietary Trading Group. Dr. Bhansali was then at PIMCO for 16 years, serving the last 8 years as managing director and head of the Quantitative Portfolios Team, which he founded in 2008. He is the author of four books on finance, including Bond Portfolio Investing and Risk Management and Tail Risk Hedging, and has written more than 30 refereed papers on topics from option pricing to asset allocation in such leading journals as the Journal of Finance, Financial Analysts Journal, and Journal of Portfolio Management. Dr. Bhansali has received numerous awards, including the Graham and Dodd Scroll Award, and serves on the investment committee of the Margaret A. Cargill Philanthropies and on the board of trustees of MSRI and the Q Group. He holds a BS and an MS in physics from Caltech and a PhD in theoretical physics from Harvard University.