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Supply and Demand and the Term Structure of Interest Rates

Author

Listed:
  • Robin Greenwood

    (National Bureau of Economic Research, Cambridge, Massachusetts, USA
    Harvard Business School, Cambridge, Massachusetts, USA)

  • Samuel Hanson

    (National Bureau of Economic Research, Cambridge, Massachusetts, USA
    Harvard Business School, Cambridge, Massachusetts, USA)

  • Dimitri Vayanos

    (Center for Economic Policy Research, Paris, France
    National Bureau of Economic Research, Cambridge, Massachusetts, USA
    Department of Finance, London School of Economics, London, United Kingdom)

Abstract

We survey the growing literature emphasizing the role that supply and demand forces play in shaping the term structure of interest rates. Our starting point is the Vayanos and Vila model of the term structure of default-free bond yields, which we present in both discrete and continuous time. The key friction in the model is that the bond market is partially segmented from other financial markets: The prices of short-rate and bond supply risks are set by specialized bond arbitrageurs who must absorb shocks to the supply and demand for bonds from other preferred-habitat agents. We discuss extensions of this model in the context of default-free bonds and other asset classes.

Suggested Citation

  • Robin Greenwood & Samuel Hanson & Dimitri Vayanos, 2024. "Supply and Demand and the Term Structure of Interest Rates," Annual Review of Financial Economics, Annual Reviews, vol. 16(1), pages 115-151, November.
    • Handle: RePEc:anr:refeco:v:16:y:2024:p:115-151
    DOI: 10.1146/annurev-financial-082123-110048
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    Keywords

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    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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