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I was told that the following two US treasury bonds diverged in yields during 2008 crisis up to 80 bps. what was the reason for it ? They are both matured in 15th Aug 2015 but has different coupon rates.

  1. T 10.625% 8/15, with a higher yield
  2. T 4.25% 8/15
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    $\begingroup$ Higher coupon means lower duration and probably convexity. That's potentially one of the reasons. Without more details it is hard to tell. $\endgroup$
    – phdstudent
    Jul 9, 2020 at 21:39
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    $\begingroup$ Also, they were issued at different times (huge difference in coupon rates, which reflect interest rate at issuance), and the older one may have had much less liquidity. (>10% coupon probably issued in 1975-1985 years) $\endgroup$
    – nbbo2
    Jul 9, 2020 at 21:40
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    $\begingroup$ The short story is that those high coupon issues were very seasoned. During the crisis, they completely lost liquidity and there was virtually no trading. Assuming you really needed to offload them, you'd have to sell at a steep discount (aka higher yield). Same thing happened to the inflation-linked bonds; same credit as nominal Treasuries, but yields on them spiked because of liquidity. $\endgroup$
    – Helin
    Jul 9, 2020 at 21:51
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    $\begingroup$ If you want to do more research on it the 10.625 bond is CUSIP 912810DS4. The offering circular came out August 1, 1985 and the bond date was August 15 1985 (so it was a 30 year bond), the 4.25 is 912828EE6, they were dated August 15 2005 (so it was a 10 year bond). $\endgroup$
    – nbbo2
    Jul 9, 2020 at 22:16

1 Answer 1

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Just to elaborate on the comments above to include some visuals. As you pointed out, the high coupon, seasoned 10.625s traded at a steep discount. The first chart below shows the yield spread against 4.25s; the spread blew up to 80 bps at one point in 2008:

enter image description here

This phenomenon was not unique to these two bonds. Toward the end of 2008, many Treasuries traded out of whack. The chart below shows the yield curve as of December 15, 2008. As you can see, nearly all the seasoned high coupon issues traded at meaningful discounts (aka high yields), while all the most liquid issues captured enormous premia (i.e., they were priced at much lower yields).

enter image description here

The reason is simply liquidity. This was a time of great uncertainty and flight-to-quality/flight-to-liquidity was all that mattered. Everyone was forced to sell things to either de-lever or raise cash. Anything illiquid was marked down – no one wanted to take on the illiquidity risk, so you really have to offer to sell illiquid things at very cheap prices. Even then, there was no gaurantee that anyone would bite, and this was true for US Treasuries as well. By contrast, benchmark issues, which were pretty much the only things that still traded, got so well bid & marked up because of everyone valued liquidity.

Note that this is also not unique to the 2008 crisis. It happens all the time. It happened in the 1998 crisis, and it happened early this year, just not to the same extent.

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