Working Paper: NBER ID: w15487
Authors: Dimitri Vayanos; Jean-Luc Vila
Abstract: We model the term structure of interest rates as resulting from the interaction between investor clienteles with preferences for specific maturities and risk-averse arbitrageurs. Because arbitrageurs are risk averse, shocks to clienteles' demand for bonds affect the term structure---and constitute an additional determinant of bond prices to current and expected future short rates. At the same time, because arbitrageurs render the term structure arbitrage-free, demand effects satisfy no-arbitrage restrictions and can be quite different from the underlying shocks. We show that the preferred-habitat view of the term structure generates a rich set of implications for bond risk premia, the effects of demand shocks and of shocks to short-rate expectations, the economic role of carry trades, and the transmission of monetary policy.
Keywords: Term Structure; Interest Rates; Preferred Habitat; Bond Risk Premia
JEL Codes: E4; E5; G1
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Demand shocks from specific clienteles (D12) | term structure of interest rates (E43) |
| Risk-averse arbitrageurs integrate demands (D11) | no-arbitrage framework (G19) |
| Short rate increases (E43) | price drops (D49) |
| Short rate increases (E43) | yield increases (G12) |
| Short rate decreases (E43) | price increases (E30) |
| Short rate decreases (E43) | yield decreases (Q31) |