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Harvard’s John Campbell Analyzes the Risks of Government Bonds

On October 15, 2008, the 14th Barcelona Economics Lecture featured Harvard Professor John Y. Campbell, who visited the Barcelona economics community to speak about the risks of government bonds.

The talk was opened by Barcelona GSE Affiliated Professor and UPF Professor Teresa Garcia-Milà, and GSE Affiliated Professor and UAB Professor Salvador Barberà, who is Director of the Barcelona GSE Research Network.

Prof. Barberà welcomed Prof. Campbell to the Barcelona Economics Lectures, describing him as one of the most cited scholars in the field of financial economics and in the field of economics at large, and joking that the audience members would attempt to resist the urge to exploit his knowledge for their personal financial matters.

The Barcelona Economics Lectures bring some of the world’s foremost experts to Barcelona to share their research. In 2008, the GSE Research Network organized three other Barcelona Economics Lectures, featuring Mr. Jean-Claude Trichet (President, European Central Bank), Prof. Hugo Sonnenschein (University of Chicago), and Prof. Robert Barro (Harvard University).

Prof. Garcia-Milà, who serves on the Academic Program Council of the GSE, introduced the Barcelona Economics Lecture, describing it as the bridge that “uses knowledge to bring together the academic and business worlds—a bridge that allows us to enjoy firsthand the research of the most outstanding researchers in the economics community.”

The Barcelona GSE Research Network officially came into being at the beginning of 2008, when it took over the organization and administration of the Xarxa de Referència d'R+D+I en Economia Analítica (CREA). It is supported by the Government of Catalonia, directed by Prof. Salvador Barberà, and consists of Barcelona GSE Affiliated Professors and researchers from Catalan institutions.

Prof. Campbell began his lecture by describing the title of the talk, “What are the Risks of Government Bonds” as “bizarre and quixotic, given the recently crisis in which government bonds are the only refuge.”

“In the panic of 2008,” he said, “people who have held short term government debt have found that it has stable value, and those who have held long term government bonds have found that those are the only assets that have increasing value”.

Because of these new developments, “it has become conventional wisdom at the moment that government bonds are not only safe, but are better than safe because they are hedges against a financial crisis that has driven down the prices of all other assets.”

Continuing, Prof Campbell explained why government bonds are regarded as safe, and why they have performed so well historically. His analysis concentrated on nominal long term government bonds, discussing their inflation risk and investigating how changes over time of several factors, and in particular of the covariance between inflation and recession, affects the pricing of these bonds. Finally, he discussed asset allocation and drew some implications for investor portfolios, concluding that bonds can be used to hedge against deflation, but that the hedge fails in stagflation.

Related:

Inflation Bets or Deflation Hedges? The Changing Risks of Nominal Bonds(with Adi Sunderam and Luis M. Viceira)

"The Term Structure of the Risk-Return Tradeoff " (appendix) (with Luis Viceira)