Working Paper: CEPR ID: DP6694
Authors: Robin Greenwood; Dimitri Vayanos
Abstract: We examine empirically how the maturity structure of government debt affects bond yields and excess returns. Our analysis is based on a theoretical model of preferred habitat in which clienteles with strong preferences for specific maturities trade with arbitrageurs. Consistent with the model, we find that (i) the supply of long- relative to short-term bonds is positively related to the term spread, (ii) supply predicts positively long-term bonds' excess returns even after controlling for the term spread and the Cochrane-Piazzesi factor, (iii) the effects of supply are stronger for longer maturities, and (iv) following periods when arbitrageurs have lost money, both supply and the term spread are stronger predictors of excess returns.
Keywords: bond prices; limited arbitrage; preferred habitat; return predictability
JEL Codes: G1; H6
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| risk aversion (D81) | predictive power of supply and term spread on excess returns (G17) |
| supply of long-term bonds (E43) | term spread (C41) |
| term spread (C41) | excess returns of long-term bonds (G12) |
| supply of long-term bonds (E43) | excess returns of long-term bonds (G12) |
| supply of long-term bonds (E43) | yields of long-term bonds (E43) |