Idiosyncratic returns and relative value in the US Treasury market

This paper documents a simple and implementable security selection strategy that has generated a significantly positive risk-adjusted alpha in the US Treasury bond market from 1990 to 2015. The strategy is based on identifying relatively misvalued securities based on the Nelson-Siegel (1987) curve, while controlling for unobserved bond specific factors that may lead to persistent value effects. These results are surprising as the liquidity and depth of the US Treasury market substantially reduces barriers to arbitrage. Our findings are robust to controls for duration, known risk factors, and a placebo “random” selection strategy.