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The Case of the Negative Nominal Interest Rates: New Estimates of the Term Structure of Interest Rates During the Great Depression

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  • Stephen G. Cecchetti

Abstract

During the 1930s and early 1940s U.S. Treasury bonds and notes had negative nominal yields as they approached maturity. But since an investor can always hold cash, this is impossible. Any bond must have a positive nominal yield. This paper poses a resolution to this puzzle: in addition to making coupon payments, Treasury securities were options that gave the owner the right to buy a new security on a future date. The paper proposes a method for valuing this 'exchange privilege' and computing the yield to the coupon bearing component of these composite bond/options. The case of the negative nominal interest rates demonstrates that the construction of accurate data requires close examination of the institutional environment, even when studying financial markets. The corrected bond and note yields are used to calculate new estimates of the term structure of interest rates from 1929 to 1949. These new data allow one to follow changes in the both the level and the shape of the yield curve during the Great Depression.

Suggested Citation

  • Stephen G. Cecchetti, 1987. "The Case of the Negative Nominal Interest Rates: New Estimates of the Term Structure of Interest Rates During the Great Depression," NBER Working Papers 2472, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:2472
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    1. Shea, Gary S, 1985. " Interest Rate Term Structure Estimation with Exponential Splines: A Note," Journal of Finance, American Finance Association, vol. 40(1), pages 319-325, March.
    2. McCulloch, J Huston, 1971. "Measuring the Term Structure of Interest Rates," The Journal of Business, University of Chicago Press, vol. 44(1), pages 19-31, January.
    3. John C. Cox & Jonathan E. Ingersoll Jr. & Stephen A. Ross, 2005. "A Theory Of The Term Structure Of Interest Rates," World Scientific Book Chapters,in: Theory Of Valuation, chapter 5, pages 129-164 World Scientific Publishing Co. Pte. Ltd..
    4. N. Gregory Mankiw & Jeffrey A. Miron, 1986. "The Changing Behavior of the Term Structure of Interest Rates," The Quarterly Journal of Economics, Oxford University Press, vol. 101(2), pages 211-228.
    5. Bernanke, Ben S, 1983. "Nonmonetary Effects of the Financial Crisis in Propagation of the Great Depression," American Economic Review, American Economic Association, vol. 73(3), pages 257-276, June.
    6. Brown, Stephen J & Dybvig, Philip H, 1986. " The Empirical Implications of the Cox, Ingersoll, Ross Theory of the Term Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 41(3), pages 617-630, July.
    7. Hamilton, James D., 1987. "Monetary factors in the great depression," Journal of Monetary Economics, Elsevier, vol. 19(2), pages 145-169, March.
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