Bond convenience yields in the Eurozone

This paper asks why government borrowing costs differ so much within the Eurozone, even though all member countries share a common currency and a common short-term interest rate. The central idea is that some government bonds—especially German Bunds—are valued not just as investments but also as safe, liquid stores of value. Investors are willing to accept lower returns to hold them, generating what economists call a “convenience yield.” While most research on this topic focuses on U.S. Treasuries, this paper shows that convenience yields are also central to understanding bond pricing inside the Eurozone. Because countries cannot adjust their own interest rates or use inflation to absorb fiscal shocks, differences in convenience yields become an important mechanism through which markets react to country-specific fiscal news.

The paper documents three key facts. First, the convenience yield varies widely across Eurozone countries and over time, peaking during episodes like the 2011–12 sovereign debt crisis and the COVID shock. Second, these convenience yields account for a surprisingly large share of differences in borrowing costs across countries—often larger than differences in default risk premia. Third, the convenience yield responds systematically to fiscal conditions: countries that run stronger public finances receive higher convenience yields and therefore borrow more cheaply. This relationship is economically large, forward-looking, and robust to alternative explanations such as liquidity differences.

The Portuguese case illustrates the mechanism clearly: as Portugal’s fiscal outlook improved over the past decade, its convenience yield rose, reducing its funding costs even though it remained outside the “core” group of Eurozone safe-asset issuers. The results suggest that convenience yields act as a shock absorber in a currency union, rewarding fiscal discipline even when monetary policy cannot differentiate across members. They also show that the Eurozone’s institutional design creates both advantages and disadvantages: safe-asset status brings major fiscal benefits, but these benefits are not evenly shared.

Click here to go to the paper by Zhengyang Jiang, Hanno Lustig, Stijn Van Nieuwerburgh, Mindy Z. Xiaolan.