Valuation Process and Market Efficiency for US Treasury Bonds

Abstract

This paper investigates the efficiency of the bond valuation process by analyzing the effect of a call announcement on the US Treasury bond market. The Treasury's action surprised many investors since the Government had not called bonds for the preceding 30 years. Quick adjustment of prices to new information is an indicator of the efficiency with which investors incorporate changing expectations into the valuation process. Research on stock market efficiency is widely available. However, the limited research that exists on bond market efficiency focuses on corporate bonds. Our study extends the literature by providing empirical evidence on bond market changes that result from the announced call of US Treasury bonds. The focus on US government issues avoids the confounding effects of taxes, default risk, agency problems, restrictive covenants, and leverage that are associated with corporate issues. In addition, the research provides empirical evidence on the valuation of put options implicit in US Treasury bonds.