Government bonds are supposed to offer a positive return with very low risk.
Government bonds are issued on the primary market for sovereign debt and then traded on the secondary market for sovereign debt. The government (the borrower) borrows at a fixed or variable rate for a given maturity from investors (creditors) on the financial markets.
Government bonds are generally considered less risky than corporate bonds because governments theoretically have a lower probability of credit events (this risk is quantified and then ranked by rating agencies), which guarantees the capital invested. A generally fixed interest rate and low volatility mean that government bonds are considered « less » risky assets than certain securities such as stocks. Investors offer their capital in exchange for a real interest rate that (1) increases with the nominal interest rate, (2) decreases with the inflation rate, and (3) increases with the risk premium. The low risk of government insolvency justifies a low risk premium, hence the « less » risky nature of government bonds.
Changes in risk premiums justify the debate on the « lower » risk nature of government bonds
In the eurozone, the risks of unsustainable public finances for several major issuers such as Italy and Spain in 2012, combined with political and/or institutional risk, contributed (1) to a downgrade of certain sovereign debts by rating agencies and (2) to an increase in the risk of contagion in the sovereign debt market. This led to an increase in risk premiums. Applied to short-term maturities, certain yield curves « inverted »: investors obtained a higher interest rate by lending in the short term than in the long term, but assumed a more significant risk of non-repayment. This was the case with Portuguese sovereign debt, which was a riskier asset in the short term at the beginning of 2012.
While government bonds are traditionally considered « risk-free » assets, it is clear that the crisis, particularly in the eurozone, has changed the situation. It is no longer unusual to find bonds issued by multinational companies offering lower interest rates than those of certain OECD countries. This observation leads to a redefinition of risk-free assets.
AJ
