An Australian Capital Market without CGS

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An Australian Capital Market without CGS

• Gordon de Brouwer
• Asia Pacific School of Economics and Management

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Why Capital Markets Need Government Bonds

• The main concerns are that
• risk-free asset provides the base market price
• risk-free asset is the asset of last resort
• risk-free asset is a major part of the fixed
  interest market, which is important in asset
  management
• but markets are fungible and dynamic and will
  likely create alternatives

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1. Pricing alternatives

• Market can still price an efficient portfolio
• CAPM the excess return over the zero-beta
  return (ie return with minimum variance of all
  portfolios uncorrelated with the market return)
• If the market can price the risk-free asset, it
  can price the risk-free-plus-epsilon rate
• Close to risk-free assets exist
• corporate bonds, multinational issues, US
  Treasuries
• the more predictable they are, the lower the cost
• Long-dated swaps market, priced by banks
• contestable markets new market players likely

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Corporate bond spreads
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1. Pricing alternatives

• Market can still price an efficient portfolio
• CAPM the excess return over the zero-beta
  return (ie return with minimum variance of all
  portfolios uncorrelated with the market return)
• If the market can price the risk-free asset, it
  can price the risk-free-plus-epsilon rate
• Close to risk-free assets exist
• corporate bonds, multinational issues, US
  Treasuries
• the more predictable they are, the lower the cost
• Long-dated swaps market, priced by banks
• contestable markets new market players likely

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2. Alternative assets of last resort

• Premium grade corporate paper, especially from
  banks
• Bank deposits
• guaranteed in a crisis?
• Short-term government securities
• Central bank liabilities
• nb even government bond markets may not function
  properly in the case of severe risk aversion (eg
  US Treasuries in late 1998)

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3. Alternative fixed interest assets

• Corporate bond market
• market development is endogenous
• expect
• longer maturity profile
• greater diversity of issuers because of funding
  advantages
• Hedged foreign securities
• securitisation of foreign bonds, possibly with
  foreign exchange risk covered by the securitiser
  (at a price)

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Australian fixed interest market
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Australian private LT securities
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3. Alternative fixed interest assets

• Corporate bond market
• market development is endogenous
• expect
• longer maturity profile
• greater diversity of issuers because of funding
  advantages
• Hedged foreign securities
• securitisation of foreign bonds, possibly with
  foreign exchange risk covered by the securitiser
  (at a price)