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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. Financial Markets Group Discussion Papers (641). Financial Markets Group, The 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: https://www.fmg.ac.uk/
Additional Information: © 2009 The Authors
Divisions: Financial Markets Group
Subjects: H Social Sciences > HG Finance
H Social Sciences > HB Economic Theory
JEL classification: E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E40 - General
Date Deposited: 09 Sep 2010 13:50
Last Modified: 15 Sep 2023 23:17
URI: http://eprints.lse.ac.uk/id/eprint/29308

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