Long-term Investors, Demand Shifts, and Yields

I use detailed data on bond and swap positions of pension funds and insurance companies (P&Is) in the Netherlands to study demand shifts and their causal effect on government bond yields. In particular, I exploit a reform in the regulatory discount curve that makes liabilities more sensitive to changes in the 20-year interest rate but less so to longer maturity rates. Following the reform, P&Is reduced their longest maturity holdings but increased those with maturities close to 20 years. The aggregate demand shift caused a substantial steepening of the long-end of the yield curve. Using the regulatory reform as an exogenous shock to estimate the demand elasticities of various investors in the government bond market, I show that the banking sector is most price elastic and primarily responsible for absorbing demand shocks. My findings indicate that the regulatory framework of long-term investors spills over to other sectors and directly affects the governments’ cost of borrowing.