Working Paper: NBER ID: w31879
Authors: Robin Greenwood; Samuel Hanson; Dimitri Vayanos
Abstract: We survey the growing literature emphasizing the role that supply-and-demand forces play in shaping the term structure of interest rates. Our starting point is the Vayanos and Vila (2009, 2021) model of the term structure of default-free bond yields, which we present in both discrete and continuous time. The key friction in the model is that the bond market is partially segmented from other financial markets: the prices of short-rate and bond supply risk are set by specialized bond arbitrageurs who must absorb shocks to the supply and demand for bonds from other “preferred-habitat” agents. We discuss extensions of this model in the context of default-free bonds and other asset classes.
Keywords: supply and demand; term structure; interest rates; quantitative easing; bond markets
JEL Codes: E4; E40; E49; E52; E7; G02; G1; G10; G11; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| large shocks to the supply of long-term bonds (E43) | long-term interest rates (E43) |
| bond arbitrageurs adjusting their risk premia (G12) | expected excess returns on longer-term bonds (G12) |
| expected persistence of supply shocks (E32) | impact on the yield curve (E43) |
| transient shocks (E32) | hump-shaped effect on intermediate-term yields (E43) |