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A Preferred-Habitat Model of the Term Structure of Interest Rates

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  • Jean-Luc Vila

    ()

  • Dimitri Vayanos

    ()

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.

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Bibliographic Info

Paper provided by Financial Markets Group in its series FMG Discussion Papers with number dp641.

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Date of creation: Nov 2009
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Handle: RePEc:fmg:fmgdps:dp641

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  1. Ben Bernanke and the Term Structure of Interest Rates
    by Stephen Williamson in Stephen Williamson: New Monetarist Economics on 2013-03-19 22:08:00
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