Urgency, Liquidity, and the Price of Convenience

The conventional approach to measuring a convenience yield or liquidity premium is to take two assets that differ in convenience or liquidity but are otherwise identical, and to proxy the price of convenience (PoC) with their spread. We show that this approach is insufficient. First, short-term assets are inherently liquid for non-urgent needs, therefore a spread between them reflects urgency of needs rather than liquidity of assets. Second, any spread reflects the underlying assets loadings on convenience rather than convenience itself. To solve these problems, we develop a monetary asset pricing model and estimate it with three instruments that differ in maturity and in marketability: Treasury bills, commercial paper, and AAA corporate bonds. At our headline estimate, the PoC averages 5.1% a year and varies between 3.2% and 11.4% - an order of magnitude above conventional measures - and a private claim delivers on average about half the liquidity services of a Treasury bill. On average, only 24% of the PoC is attributable to urgency.