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A Preferred-Habitat Model of Term Premia, Exchange Rates, and Monetary Policy Spillovers

Author

Listed:
  • Vayanos, Dimitri
  • Gourinchas, Pierre-Olivier
  • Ray, Walker

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 global arbitrageurs with limited capital. Our model accounts for the empirically documented violations of Uncovered Interest Parity (UIP) and the Expectations Hypothesis, and for how UIP violations depend on bond maturity, investment horizon, and yield curve slope differentials. Large-scale purchases of long-maturity bonds lower domestic and foreign bond yields, and depreciate the currency. Conventional monetary policy is transmitted to domestic and international bond yields as well, but its international transmission is weaker than for unconventional policy.

Suggested Citation

  • Vayanos, Dimitri & Gourinchas, Pierre-Olivier & Ray, Walker, 2022. "A Preferred-Habitat Model of Term Premia, Exchange Rates, and Monetary Policy Spillovers," CEPR Discussion Papers 17119, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:17119
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    Cited by:

    1. Ostry, D. A., 2023. "Tails of Foreign Exchange-at-Risk (FEaR)," Cambridge Working Papers in Economics 2343, Faculty of Economics, University of Cambridge.
    2. Cañon, Carlos & Gerba, Eddie & Pambira, Alberto & Stoja, Evarist, 2023. "An unconventional FX tail risk story," LSE Research Online Documents on Economics 120052, London School of Economics and Political Science, LSE Library.
    3. James Costain & Galo Nuño & Carlos Thomas, 2022. "The Term Structure of Interest Rates in a Heterogeneous Monetary Union," CESifo Working Paper Series 9844, CESifo.
    4. Carlos Cañon & Eddie Gerba & Alberto Pambira & Evarist Stoja, 2023. "An Unconventional FX Tail Risk Story," CESifo Working Paper Series 10629, CESifo.
    5. Malliaropulos, Dimitris & Migiakis, Petros, 2023. "A global monetary policy factor in sovereign bond yields," Journal of Empirical Finance, Elsevier, vol. 70(C), pages 445-465.
    6. Jappelli, Ruggero & Pelizzon, Loriana & Subrahmanyam, Marti G., 2023. "Quantitative easing, the repo market, and the term structure of interest rates," SAFE Working Paper Series 395, Leibniz Institute for Financial Research SAFE.
    7. International Monetary Fund, 2022. "Denmark: Selected Issues," IMF Staff Country Reports 2022/170, International Monetary Fund.

    More about this item

    Keywords

    Exchange rates; Interest rates; Monetary policy; Limits of arbitrage;
    All these keywords.

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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