The Risk and Return Characteristics of the U.S. Treasury Basis Trade

Abstract

We conduct an analysis of the risk and return characteristics of the U.S. Treasury basis trade by regressing the strategy returns of the 2-year, 5-year and 10-year futures contracts on a variety of bond and equity market risk factors. We find that over the full sample period from January 1, 1992 to March 31, 2023, the 5-year strategy generates a positively significant alpha without loading on any risk factors, whereas the 2-year strategy generates no significant alpha, and the 10-year strategy generates a negatively significant alpha, with little explanatory power even though they load on some risk factors. In the more recent sample period from August 31, 2007 to March 31, 2023, the 2-year strategy and the 5-year strategy generated highly significant alphas, which coincides with hedge fund interest in the basis trade. Further we cannot rule out that the significant alphas observed in the 2-year or 5-year contracts might stem from limits to arbitrage.