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A Preferred‐Habitat Model of the Term Structure of Interest Rates
Author(s) -
Vayanos Dimitri,
Vila JeanLuc
Publication year - 2021
Publication title -
econometrica
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 16.7
H-Index - 199
eISSN - 1468-0262
pISSN - 0012-9682
DOI - 10.3982/ecta17440
Subject(s) - yield curve , interest rate , economics , arbitrage , term (time) , asset (computer security) , monetary economics , bond , risk premium , econometrics , affine term structure model , short interest ratio , forward rate , financial economics , finance , context (archaeology) , geography , physics , computer security , archaeology , quantum mechanics , computer science
We model the term structure of interest rates that results from the interaction between investors with preferences for specific maturities and risk‐averse arbitrageurs. Shocks to the short rate are transmitted to long rates through arbitrageurs' carry trades. Arbitrageurs earn rents from transmitting the shocks through bond risk premia that relate positively to the slope of the term structure. When the short rate is the only risk factor, changes in investor demand have the same relative effect on interest rates across maturities regardless of the maturities where they originate. When investor demand is also stochastic, demand effects become more localized. A calibration indicates that long rates underreact to forward‐guidance announcements about short rates. Large‐scale asset purchases can be more effective in moving long rates, especially if they are concentrated at long maturities.