The contribution of US bond demand to the US bond yield conundrum of 2004–2007: An empirical investigation

• We model long term US Treasury, agency, corporate and municipal bond yields.
• Our ARDL models fully explain the US bond yield conundrum of 2004–2007.
• Domestic and foreign demand variables were the main yield depressing factors.
• There are strong linkages between the Treasury yield and non-Treasury bond yields.
• Our results support the search for yield hypothesis as a reason for the CDO growth.

Although the federal funds rate started rising from mid-2004 US long term rates continued to fall. A likely contributory factor to this ‘conundrum’ was the contemporaneous increase in US bond demand. Using ARDL based models, which accommodate structural breaks, this paper estimates the impact of foreign and domestic demand on AAA rated US bond yields in the ‘conundrum’ period. This impact is shown to have been everywhere significantly negative. The fact that our model fully explains the ‘bond yield conundrum’ gives support to the hypothesis that the US CDO market was rapidly expanded before 2007 chiefly to absorb the overspill of global demand for safe assets. Moreover, our models demonstrate that there are strong linkages between the 10-year Treasury yield and the long term yields of AAA rated non-Treasury bonds.