IDEAS home Printed from https://ideas.repec.org/p/ehl/lserod/126107.html
   My bibliography  Save this paper

Supply and demand and the term structure of interest rates

Author

Listed:
  • Greenwood, Robin
  • Hanson, Samuel
  • Vayanos, Dimitri

Abstract

We survey the growing literature emphasizing the role that supply and demand forces play in shaping the term structure of interest rates. Our starting point is the Vayanos and Vila model of the term structure of default-free bond yields, which we present in both discrete and continuous time. The key friction in the model is that the bond market is partially segmented from other financial markets: The prices of short-rate and bond supply risks are set by specialized bond arbitrageurs who must absorb shocks to the supply and demand for bonds from other preferred-habitat agents. We discuss extensions of this model in the context of default-free bonds and other asset classes.

Suggested Citation

  • Greenwood, Robin & Hanson, Samuel & Vayanos, Dimitri, 2024. "Supply and demand and the term structure of interest rates," LSE Research Online Documents on Economics 126107, London School of Economics and Political Science, LSE Library.
  • Handle: RePEc:ehl:lserod:126107
    as

    Download full text from publisher

    File URL: http://eprints.lse.ac.uk/126107/
    File Function: Open access version.
    Download Restriction: no
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. Gourinchas, Pierre-Olivier & Ray, Walker & Vayanos, Dimitri, 2022. "A Preferred-Habitat Model of Term Premia, Exchange Rates, and Monetary Policy Spillovers," CEPR Discussion Papers 17119, C.E.P.R. Discussion Papers.
    2. Dimitri Vayanos & Jean‐Luc Vila, 2021. "A Preferred‐Habitat Model of the Term Structure of Interest Rates," Econometrica, Econometric Society, vol. 89(1), pages 77-112, January.
    3. Arvind Krishnamurthy & Annette Vissing-Jorgensen, 2012. "The Aggregate Demand for Treasury Debt," Journal of Political Economy, University of Chicago Press, vol. 120(2), pages 233-267.
    4. J. M. Culbertson, 1957. "The Term Structure of Interest Rates," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 71(4), pages 485-517.
    5. James Costain & Galo Nuño & Carlos Thomas, 2022. "The Term Structure of Interest Rates in a Heterogeneous Monetary Union," CESifo Working Paper Series 9844, CESifo.
    6. Robin Greenwood & Annette Vissing-Jorgensen, 2018. "The Impact of Pensions and Insurance on Global Yield Curves," Harvard Business School Working Papers 18-109, Harvard Business School, revised Dec 2018.
    7. Rohan Kekre & Moritz Lenel & Federico Mainardi, 2023. "Monetary Policy, Segmentation, and the Term Structure," Working Papers 2023-08, Princeton University. Economics Department..
    8. D’Amico, Stefania & King, Thomas B., 2013. "Flow and stock effects of large-scale treasury purchases: Evidence on the importance of local supply," Journal of Financial Economics, Elsevier, vol. 108(2), pages 425-448.
    9. Marcel Fratzscher & Marco Lo Duca & Roland Straub, 2018. "On the International Spillovers of US Quantitative Easing," Economic Journal, Royal Economic Society, vol. 128(608), pages 330-377, February.
    10. Robin Greenwood & Dimitri Vayanos, 2014. "Bond Supply and Excess Bond Returns," The Review of Financial Studies, Society for Financial Studies, vol. 27(3), pages 663-713.
    11. John Y. Campbell & Robert J. Shiller, 1988. "Stock Prices, Earnings and Expected Dividends," Cowles Foundation Discussion Papers 858, Cowles Foundation for Research in Economics, Yale University.
    12. King, Thomas B., 2019. "Expectation and duration at the effective lower bound," Journal of Financial Economics, Elsevier, vol. 134(3), pages 736-760.
    13. He, Zhiguo & Nagel, Stefan & Song, Zhaogang, 2022. "Treasury inconvenience yields during the COVID-19 crisis," Journal of Financial Economics, Elsevier, vol. 143(1), pages 57-79.
    14. Neely, Christopher J., 2015. "Unconventional monetary policy had large international effects," Journal of Banking & Finance, Elsevier, vol. 52(C), pages 101-111.
    15. Michael Woodford, 2016. "Quantitative Easing and Financial Stability," Central Banking, Analysis, and Economic Policies Book Series, in: Elías Albagli & Diego Saravia & Michael Woodford (ed.),Monetary Policy through Asset Markets: Lessons from Unconventional Measures and Implications for an Integrated World, edition 1, volume 24, chapter 6, pages 151-233, Central Bank of Chile.
    16. Dietrich Domanski & Hyun Song Shin & Vladyslav Sushko, 2017. "The Hunt for Duration: Not Waving but Drowning?," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 65(1), pages 113-153, April.
    17. Gauti B. Eggertsson & Michael Woodford, 2003. "The Zero Bound on Interest Rates and Optimal Monetary Policy," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 34(1), pages 139-235.
    18. John Y. Campbell & Robert J. Shiller & Luis M. Viceira, 2009. "Understanding Inflation-Indexed Bond Markets," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 40(1 (Spring), pages 79-138.
    19. Michael A. S. Joyce & Ana Lasaosa & Ibrahim Stevens & Matthew Tong, 2011. "The Financial Market Impact of Quantitative Easing in the United Kingdom," International Journal of Central Banking, International Journal of Central Banking, vol. 7(3), pages 113-161, September.
    20. Valentin Haddad & David Sraer, 2020. "The Banking View of Bond Risk Premia," Journal of Finance, American Finance Association, vol. 75(5), pages 2465-2502, October.
    21. Saroj Bhattarai & Christopher J. Neely, 2022. "An Analysis of the Literature on International Unconventional Monetary Policy," Journal of Economic Literature, American Economic Association, vol. 60(2), pages 527-597, June.
    22. Joseph Gagnon & Matthew Raskin & Julie Remache & Brian Sack, 2011. "The Financial Market Effects of the Federal Reserve's Large-Scale Asset Purchases," International Journal of Central Banking, International Journal of Central Banking, vol. 7(1), pages 3-43, March.
    23. repec:bla:jfinan:v:43:y:1988:i:3:p:661-76 is not listed on IDEAS
    24. Eric Sims & Jing Cynthia Wu & Ji Zhang, 2023. "The Four-Equation New Keynesian Model," The Review of Economics and Statistics, MIT Press, vol. 105(4), pages 931-947, July.
    25. Hanson, Samuel G. & Stein, Jeremy C., 2015. "Monetary policy and long-term real rates," Journal of Financial Economics, Elsevier, vol. 115(3), pages 429-448.
    26. Samuel G Hanson & David O Lucca & Jonathan H Wright, 2021. "Rate-Amplifying Demand and the Excess Sensitivity of Long-Term Rates," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 136(3), pages 1719-1781.
    27. John Y. Campbell & Robert J. Shiller & Luis M. Viceira, 2009. "Understanding Inflation-Indexed Bond Markets," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 40(1 (Spring), pages 79-138.
    28. Darrell Duffie, 2010. "Presidential Address: Asset Price Dynamics with Slow‐Moving Capital," Journal of Finance, American Finance Association, vol. 65(4), pages 1237-1267, August.
    29. Robin Greenwood & Samuel Hanson & Jeremy C Stein & Adi Sunderam, 2023. "A Quantity-Driven Theory of Term Premia and Exchange Rates," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 138(4), pages 2327-2389.
    30. Hayashi, Fumio, 2018. "Computing equilibrium bond prices in the Vayanos-Vila model," Research in Economics, Elsevier, vol. 72(2), pages 181-195.
    31. Walker Ray, 2019. "Monetary Policy and the Limits to Arbitrage: Insights from a New Keynesian Preferred Habitat Model," 2019 Meeting Papers 692, Society for Economic Dynamics.
    32. Robin Greenwood & Samuel G Hanson & Gordon Y Liao, 2018. "Asset Price Dynamics in Partially Segmented Markets," The Review of Financial Studies, Society for Financial Studies, vol. 31(9), pages 3307-3343.
    33. Robin Greenwood & Dimitri Vayanos, 2010. "Price Pressure in the Government Bond Market," American Economic Review, American Economic Association, vol. 100(2), pages 585-590, May.
    34. Fama, Eugene F & Bliss, Robert R, 1987. "The Information in Long-Maturity Forward Rates," American Economic Review, American Economic Association, vol. 77(4), pages 680-692, September.
    35. Hanno Lustig & Andreas Stathopoulos & Adrien Verdelhan, 2019. "The Term Structure of Currency Carry Trade Risk Premia," American Economic Review, American Economic Association, vol. 109(12), pages 4142-4177, December.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Dimitri Vayanos & Jean‐Luc Vila, 2021. "A Preferred‐Habitat Model of the Term Structure of Interest Rates," Econometrica, Econometric Society, vol. 89(1), pages 77-112, January.
    2. Jappelli, Ruggero & Pelizzon, Loriana & Subrahmanyam, Marti G., 2023. "Quantitative easing, the repo market, and the term structure of interest rates," SAFE Working Paper Series 395, Leibniz Institute for Financial Research SAFE.
    3. Valentin Haddad & Alan Moreira & Tyler Muir, 2021. "When Selling Becomes Viral: Disruptions in Debt Markets in the COVID-19 Crisis and the Fed’s Response [Funding value adjustments]," The Review of Financial Studies, Society for Financial Studies, vol. 34(11), pages 5309-5351.
    4. Sophocles N. Brissimis & Evangelia A. Georgiou, 2022. "The effects of Federal Reserve's quantitative easing and balance sheet normalization policies on long-term interest rates," Working Papers 299, Bank of Greece.
    5. Robin Greenwood & Samuel G. Hanson & Jeremy C. Stein & Adi Sunderam, 2020. "A Quantity-Driven Theory of Term Premia and Exchange Rates," NBER Working Papers 27615, National Bureau of Economic Research, Inc.
    6. Tischer, Johannes, 2018. "Quantitative easing, portfolio rebalancing and credit growth: Micro evidence from Germany," Discussion Papers 20/2018, Deutsche Bundesbank.
    7. Malliaropulos, Dimitris & Migiakis, Petros, 2023. "A global monetary policy factor in sovereign bond yields," Journal of Empirical Finance, Elsevier, vol. 70(C), pages 445-465.
    8. Equiza, Juan & Gimeno, Ricardo & Moreno, Antonio & Thomas, Carlos, 2024. "Evaluating the yield curve effects of central bank asset purchases under a forward-looking supply factor," European Economic Review, Elsevier, vol. 165(C).
    9. Hanson, Samuel G. & Malkhozov, Aytek & Venter, Gyuri, 2024. "Demand-and-supply imbalance risk and long-term swap spreads," Journal of Financial Economics, Elsevier, vol. 154(C).
    10. Caio Almeida & Kym Ardison & Daniela Kubudi & Axel Simonsen & José Vicente, 2018. "Forecasting Bond Yields with Segmented Term Structure Models," Journal of Financial Econometrics, Oxford University Press, vol. 16(1), pages 1-33.
    11. Christoph Trebesch & Jeromin Zettelmeyer, 2018. "ECB Interventions in Distressed Sovereign Debt Markets: The Case of Greek Bonds," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 66(2), pages 287-332, June.
    12. Hanson, Samuel G., 2014. "Mortgage convexity," Journal of Financial Economics, Elsevier, vol. 113(2), pages 270-299.
    13. Simon Gilchrist & Egon ZakrajŠEk, 2013. "The Impact of the Federal Reserve's Large-Scale Asset Purchase Programs on Corporate Credit Risk," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 45(s2), pages 29-57, December.
    14. Cenedese, Gino & Elard, Ilaf, 2021. "Unconventional monetary policy and the portfolio choice of international mutual funds," Journal of International Money and Finance, Elsevier, vol. 115(C).
    15. Neely, Christopher J., 2022. "How persistent are unconventional monetary policy effects?," Journal of International Money and Finance, Elsevier, vol. 126(C).
    16. Driessen, Joost & Nijman, Theodore E. & Simon, Zorka, 2022. "A simple approach to estimate long-term interest rates," SAFE Working Paper Series 238, Leibniz Institute for Financial Research SAFE, revised 2022.
    17. Valentin Haddad & Alan Moreira & Tyler Muir, 2020. "When Selling Becomes Viral: Disruptions in Debt Markets in the COVID-19 Crisis and the Fed’s Response," NBER Working Papers 27168, National Bureau of Economic Research, Inc.
    18. Pagliari, Maria Sole, 2024. "Does one (unconventional) size fit all? Effects of the ECB’s unconventional monetary policies on the euro area economies," European Economic Review, Elsevier, vol. 168(C).
    19. Cantore, Cristiano & Meichtry, Pascal, 2023. "Unwinding quantitative easing: state dependency and household heterogeneity," Bank of England working papers 1030, Bank of England.
    20. Carolin E. Pflueger & Luis M. Viceira, 2011. "Return Predictability in the Treasury Market: Real Rates, Inflation, and Liquidity," Harvard Business School Working Papers 11-094, Harvard Business School, revised Sep 2013.

    More about this item

    Keywords

    term structure of interest rates; monetary policy; bond demand; bond supply; market segmentation; preferred habitat; limited arbitrage;
    All these keywords.

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:ehl:lserod:126107. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: LSERO Manager (email available below). General contact details of provider: https://edirc.repec.org/data/lsepsuk.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.