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Bond supply and excess bond returns

  • Robin Greenwood
  • Dimitri Vayanos

We examine empirically how the maturity structure of government debt affects bond yields and excess returns. Our analysis is based on a theoretical model of preferred habitat in which clienteles with strong preferences for specific maturities trade with arbitrageurs. Consistent with the model, we find that (i) the supply of long- relative to short-term bonds is positively related to the term spread, (ii) supply predicts positively long-term bonds' excess returns even after controlling for the term spread and the Cochrane-Piazzesi factor, (iii) the e®ects of supply are stronger for longer maturities, and (iv) following periods when arbitrageurs have lost money, both supply and the term spread are stronger predictors of excess returns.

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Paper provided by London School of Economics and Political Science, LSE Library in its series LSE Research Online Documents on Economics with number 24425.

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Length: 47 pages
Date of creation: 01 Feb 2008
Date of revision:
Handle: RePEc:ehl:lserod:24425
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  1. Dimitri Vayanos & Denis Gromb, 2012. "Financially constrained arbitrage and cross-market contagion," 2012 Meeting Papers 112, Society for Economic Dynamics.
  2. Dimitri Vayanos & Jean-Luc Vila, 2009. "A preferred-habitat model of the term structure of interest rates," LSE Research Online Documents on Economics 29308, London School of Economics and Political Science, LSE Library.
  3. Gromb, Denis & Vayanos, Dimitri, 2001. "Equilibrium and Welfare in Markets with Financially Constrained Arbitrageurs," CEPR Discussion Papers 3049, C.E.P.R. Discussion Papers.
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  18. Fama, Eugene F & Bliss, Robert R, 1987. "The Information in Long-Maturity Forward Rates," American Economic Review, American Economic Association, vol. 77(4), pages 680-92, September.
  19. Xavier Gabaix & Arvind Krishnamurthy & Olivier Vigneron, 2005. "Limits of Arbitrage: Theory and Evidence from the Mortgage-Backed Securities Market," NBER Working Papers 11851, National Bureau of Economic Research, Inc.
  20. N. Gregory Mankiw & Matthew D. Shapiro, 1985. "Do We Reject Too Often? Small Sample Properties of Tests of Rational Expectations Models," NBER Technical Working Papers 0051, National Bureau of Economic Research, Inc.
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