Optimal portfolio allocation in a world without Treasury securities

Abstract

If current financial market trends persist, US Treasury securities are bound to account for an increasingly smaller share of the fixed-income market in the USA. This paper examines the extent to which investors' portfolio allocation decisions are likely to be affected by the relative reduction in the stock of federal government debt. The analysis suggests only small effects for most investors, especially, as is effectively the case for many institutional investors, when a no-short-sales constraint is in place. Under such circumstances, highly conservative investors — whose portfolios have risk-return characteristics akin to money market instruments — and very aggressive investors — who hold mostly equities — stand to be the least affected by the removal of Treasuries from the pool of investable assets. The analysis abstracts from indirect beneficial effects on investors from a Treasury debt pay-off, such as the potential for greater productivity growth (and faster wealth accumulation) as more resources are freed up for investment in the private sector.