A preferred-habitat model of the term structure of interest rates

Dimitri Vayanos and Jean-Luc Vila

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

Abstract: We model the term structure of interest rates that results from the interaction between investors with preferences for specific maturities and risk‐averse arbitrageurs. Shocks to the short rate are transmitted to long rates through arbitrageurs' carry trades. Arbitrageurs earn rents from transmitting the shocks through bond risk premia that relate positively to the slope of the term structure. When the short rate is the only risk factor, changes in investor demand have the same relative effect on interest rates across maturities regardless of the maturities where they originate. When investor demand is also stochastic, demand effects become more localized. A calibration indicates that long rates underreact to forward‐guidance announcements about short rates. Large‐scale asset purchases can be more effective in moving long rates, especially if they are concentrated at long maturities.

Keywords: interest rates; bond risk premia; limited arbitrage; government debt; monetary policy; LSE Paul Woolley Centre (search for similar items in EconPapers)
JEL-codes: F3 G3 J1 (search for similar items in EconPapers)
Pages: 36 pages
Date: 2021-01-01
New Economics Papers: this item is included in nep-mon
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Citations: View citations in EconPapers (79)

Published in Econometrica, 1, January, 2021, 89(1), pp. 77 - 112. ISSN: 0012-9682

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http://eprints.lse.ac.uk/106509/ Open access version. (application/pdf)

Related works:
Working Paper: A Preferred-Habitat Model of the Term Structure of Interest Rates (2009)
Working Paper: A preferred-habitat model of the term structure of interest rates (2009)
Working Paper: A Preferred-Habitat Model of the Term Structure of Interest Rates (2009)
Working Paper: A Preferred-Habitat Model of the Term Structure of Interest Rates (2009)
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