Safety by Designation

Abstract

We show that safe-asset status is shaped not only by fundamental risk but also by regulatory designation. We identify this effect from sequential changes in the regulatory treatment of U.S. municipal and Treasury securities. Designating qualifying municipal bonds as high-quality liquid assets substantially increases their co-movement with Treasuries, particularly for highly rated securities and relative to assets whose regulatory treatment remains unchanged. Conversely, temporarily exempting Treasuries from the Supplementary Leverage Ratio reduces their co-movement with near-safe assets, with the effect reversing when the exemption expires. Cross-asset and within-municipal-bond tests, together with decompositions of yields, show that these effects operate through convenience yields rather than credit risk, taxes, or aggregate financial conditions. Our evidence establishes regulatory treatment as a distinct determinant of the convenience services and safe-asset properties of securities. Joint paper with Patrick Augustin, Marti G. Subrahmanyam, and Davide Tomio.