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

Vayanos, Dimitri and Vila, Jean-Luc (2009) A preferred-habitat model of the term structure of interest rates. Discussion paper, 641. Financial Markets Group, London School of Economics and Political Science, London, UK.

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Abstract

We model the term structure of interest rates as resulting from the interaction between investor clienteles with preferences for specific maturities and risk-averse arbitrageurs. Because arbitrageurs are risk averse, shocks to clienteles’ demand for bonds affect the term structure— and constitute an additional determinant of bond prices to current and expected future short rates. At the same time, because arbitrageurs render the term structure arbitrage-free, demand effects satisfy no-arbitrage restrictions and can be quite different from the underlying shocks. We show that the preferred-habitat view of the term structure generates a rich set of implications for bond risk premia, the effects of demand shocks and of shocks to short-rate expectations, the economic role of carry trades, and the transmission of monetary policy.

Item Type: Monograph (Discussion Paper)
Official URL: http://fmg.lse.ac.uk
Additional Information: © 2009 The authors
Library of Congress subject classification: H Social Sciences > HG Finance
H Social Sciences > HB Economic Theory
Sets: Research centres and groups > Financial Markets Group (FMG)
Collections > Economists Online
Collections > LSE Financial Markets Group (FMG) Working Papers
Rights: http://www.lse.ac.uk/library/usingTheLibrary/academicSupport/OA/depositYourResearch.aspx
Identification Number: 641
Date Deposited: 09 Sep 2010 13:50
URL: http://eprints.lse.ac.uk/29308/

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