Convenience Yields and Asset Pricing Models

Abstract

Convenience yields on safe assets affect the constraints that asset price data impose on asset pricing models. We show that high Sharpe ratios imply either a volatile stochastic discount factor or a high convenience yield, which generalizes the Hansen-Jagannathan bound. We apply this insight to the Treasury market by incorporating convenience yields into affine term structure models. The solutions link yields across the entire term structure to SDF and convenience yield dynamics. We show that introducing convenience yields rules in more economically sensible models. This improvement becomes more pronounced as we adopt more realistic convenience yield measures.

Keywords: Bond Returns, convenience yields, sharpe ratios, Hansen-Jagannathan bound