'The Case of the Negative Nominal Interest Rates: New Estimates of the Term Structure of Interest Rates During the Great Depression,' Journal of Political Economy 96 (December 1988) 1111-1141.
Throughout the 1930s and early 1940s U.S. Treasury bonds and notes appeared to have negative nominal yields as they approached maturity. But negative nominal interest rates are impossible in a world where one can always hold cash. The resolution to this puzzle is that Treasury securities, in addition to making coupon payments, gave the owner the right to buy a new security on a future date. This paper describes the institutional environment that led to the apparent negative nominal interest rates, develops a method for valuing the `exchange privilege' and computes accurate measures of the yield to the coupon bearing component of these composite bond/options. These corrected bond and note yields are then used to calculate new estimates of the term structure of interest rates from 1929 to 1949.