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Expectation and duration at the effective lower bound

Thomas King

Journal of Financial Economics, 2019, vol. 134, issue 3, 736-760

Abstract: With risk-averse arbitrageurs and an effective lower bound (ELB) on nominal rates, nonlinear interactions among short-rate expectations, bond supply, and term premia emerge in equilibrium. These interactions, which are absent from affine models, help explain the observed behavior of the yield curve near the ELB, including evidence about unconventional monetary policy. The impact of both short-rate expectations and bond supply are attenuated at the ELB. However, in simulations of the post-crisis experience in the U.S., shocks to investors’ duration-risk exposures have much smaller effects than shocks to the anticipated path of short rates. The latter shocks matter, in part, because of the reduction in interest-rate volatility associated with a longer expected stay at the ELB—a novel channel of unconventional policy.

Keywords: Term structure; Portfolio balance; ZLB; Quantitative easing; Forward guidance (search for similar items in EconPapers)
JEL-codes: E43 E52 G12 (search for similar items in EconPapers)
Date: 2019
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Working Paper: Expectation and Duration at the Effective Lower Bound (2016) Downloads
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DOI: 10.1016/j.jfineco.2019.05.009

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