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Liquidity Effects in the Bond Market

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  • Boyan Jovanovic
  • Peter L. Rousseau

Abstract

Our paper reports the following two findings: 1) In monthly data, bond purchases by the Fed raise bond prices and reduce bond yields. The residual bond-supply to traders is not fully predictable, and this supply-risk adds between 10 and 40 basis points to the standard deviation of the real interest rate on T-bills. 2) The Fed's open market purchases do not raise stock prices or reduce stock returns. If anything, they raise stock returns. More generally, bonds and stocks do not co-move at high frequencies. To explain these two facts, we model the bond and stock markets as spatially separate or 'segmented'. In the model, bond purchases lower bond rates, but they do not affect stock returns, and this is consistent with both facts.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 8597.

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Date of creation: Nov 2001
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Publication status: published as Boyan Jovanovic & Peter L. Rousseau, 2001. "Liquidity effects in the bond market," Economic Perspectives, Federal Reserve Bank of Chicago, issue Q IV, pages 17-35.
Handle: RePEc:nbr:nberwo:8597

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  1. Cammack, Elizabeth B, 1991. "Evidence on Bidding Strategies and the Information in Treasury Bill Auctions," Journal of Political Economy, University of Chicago Press, vol. 99(1), pages 100-130, February.
  2. Robert B. Barsky, 1986. "Why Don't the Prices of Stocks and Bonds Move Together?," NBER Working Papers 2047, National Bureau of Economic Research, Inc.
  3. Fernando Alvarez & Robert E. Lucas, Jr. & Warren E. Weber, 2001. "Interest rates and inflation," Working Papers 609, Federal Reserve Bank of Minneapolis.
  4. Milton Friedman & Anna Jacobson Schwartz, 1970. "Monetary Statistics of the United States: Estimates, Sources, Methods," NBER Books, National Bureau of Economic Research, Inc, number frie70-1.
  5. Lucas, Robert Jr., 1990. "Liquidity and interest rates," Journal of Economic Theory, Elsevier, vol. 50(2), pages 237-264, April.
  6. Christiano, Lawrence J & Eichenbaum, Martin, 1995. "Liquidity Effects, Monetary Policy, and the Business Cycle," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 27(4), pages 1113-36, November.
  7. Grossman, Sanford & Weiss, Laurence, 1983. "A Transactions-Based Model of the Monetary Transmission Mechanism," American Economic Review, American Economic Association, vol. 73(5), pages 871-80, December.
  8. Shleifer, Andrei, 1986. " Do Demand Curves for Stocks Slope Down?," Journal of Finance, American Finance Association, vol. 41(3), pages 579-90, July.
  9. Charles L. Evans & David A. Marshall, 1997. "Monetary policy and the term structure of nominal interest rates: evidence and theory," Working Paper Series, Macroeconomic Issues WP-97-10, Federal Reserve Bank of Chicago.
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Cited by:
  1. Lundblad, Christian, 2007. "The risk return tradeoff in the long run: 1836-2003," Journal of Financial Economics, Elsevier, vol. 85(1), pages 123-150, July.
  2. Arvind Krishnamurthy & Annette Vissing-Jorgensen, 2007. "The Demand for Treasury Debt," NBER Working Papers 12881, National Bureau of Economic Research, Inc.
  3. Ellen R. McGrattan & Edward C. Prescott, 2001. "The Stock Market Crash of 1929: Irving Fisher Was Right!," NBER Working Papers 8622, National Bureau of Economic Research, Inc.
  4. Ellen R. McGrattan & Edward C. Prescott, 2003. "The 1929 stock market: Irving Fisher was right," Staff Report 294, Federal Reserve Bank of Minneapolis.

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