Bond yields and debt supply: new evidence through the lens of a preferred-habitat model

Till Strohsal

Quantitative Finance, 2017, vol. 17, issue 10, 1509-1522

Abstract: This paper examines the responsiveness of bond yields to changes in debt supply. The preferred-habitat theory predicts a positive relation between the term spread and relative supply of longer term debt, and that this relation is stronger when risk aversion is high. To capture this effect, a time-varying coefficient model is introduced and applied to German bond data. The results support the theoretical predictions and indicate substantial time variation: under high risk aversion, yield spreads react about three times more strongly than when risk aversion is low. The accumulated response of term spreads to a one standard deviation change in debt supply ranges between 4 and 46 basis points.

Date: 2017
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DOI: 10.1080/14697688.2017.1287942

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