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

Vayanos, Dimitri ORCID: 0000-0002-0944-4914 and Vila, Jean-Luc (2021) A preferred-habitat model of the term structure of interest rates. Econometrica, 89 (1). 77 - 112. ISSN 0012-9682

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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.

Item Type:	Article
Official URL:	https://onlinelibrary.wiley.com/journal/14680262
Additional Information:	© 2021 The Author(s)
Divisions:	Financial Markets Group
Subjects:	H Social Sciences > HG Finance H Social Sciences > HB Economic Theory
Date Deposited:	07 Sep 2020 14:03
Last Modified:	12 Dec 2024 02:18
URI:	http://eprints.lse.ac.uk/id/eprint/106509

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