A preferred-habitat model of term premia, exchange rates, and monetary policy spillovers

Gourinchas, Pierre-Olivier, Ray, Walker and Vayanos, Dimitri ORCID: 0000-0002-0944-4914 (2025) A preferred-habitat model of term premia, exchange rates, and monetary policy spillovers. American Economic Review, 115 (11). 3788 – 3824. ISSN 0002-8282

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Abstract

We develop a two-country model in which currency and bond markets are populated by different investor clienteles, and segmentation is partly overcome by arbitrageurs with limited capital. Risk premia in our model are time-varying, connected across markets, and consistent with the empirical violations of uncovered interest parity and expectations hypothesis. Through risk premia, large-scale bond purchases lower domestic and foreign bond yields and depreciate the currency, and short-rate cuts lower foreign yields, with smaller effects than bond purchases. Currency returns are disconnected from long-maturity bond returns, and yet the currency market is instrumental in transmitting bond demand shocks across countries.

Item Type:	Article
Divisions:	Finance
Subjects:	H Social Sciences > HG Finance H Social Sciences > HB Economic Theory
JEL classification:	E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E43 - Determination of Interest Rates; Term Structure of Interest Rates E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E44 - Financial Markets and the Macroeconomy E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E52 - Monetary Policy (Targets, Instruments, and Effects) F - International Economics > F3 - International Finance > F31 - Foreign Exchange G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing; Trading volume; Bond Interest Rates G - Financial Economics > G1 - General Financial Markets > G15 - International Financial Markets
Date Deposited:	02 Apr 2025 08:42
Last Modified:	06 Nov 2025 10:39
URI:	http://eprints.lse.ac.uk/id/eprint/127783

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