Econometrica: Jan 2021, Volume 89, Issue 1

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

https://doi.org/10.3982/ECTA17440
p. 77-112

Dimitri Vayanos, Jean‐Luc Vila

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.



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Supplement to "A Preferred-Habitat Model of the Term Structure of Interest Rates"

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Supplement to "A Preferred-Habitat Model of the Term Structure of Interest Rates"

This Online Appendix does not include the proof of Theorem 1 and the material in Appendix C. These are included in the Full Appendix, available at http://personal.lse.ac.uk/vayanos/Papers/PHMTSIR ECMAf.pdf

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