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

By Dimitri Vayanos, Jean-Luc Vila. Econometrica, 2021

392 citations recorded by the source corpus.

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.

Subfields: Economics and Econometrics, Finance

View Paper: https://www.semanticscholar.org/paper/d95d7561cb10975af324e7775c4ef6143101d10f

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Citations in the corpus

The Financial Market Effects of the Federal Reserve's Large-Scale Asset Purchases * (2012, background): “More recently, Vayanos and Vila (2009) have developed a theoretical model of the term structure based on preferred habitats of investors, which also relies on risk aversion.”