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A Portfolio-Balance Approach to the Nominal Term Structure

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Abstract

Explanations of why changes in the relative quantities of safe debt seem to affect asset prices often appeal informally to a ?portfolio balance? mechanism. I show how this type of effect can be incorporated in a general class of structural, arbitrage-free asset-pricing models using a numerical solution method that allows for a wide range of nonlinearities. I consider some applications in which the Treasury market is isolated, investors have mean-variance preferences, and the short-rate process is truncated at zero. Despite its simplicity, a version of this model incorporating inflation can fit longer-term yields well, and it suggests that fluctuations in Treasury supply explain a sizeable fraction of the historical time-series variation in term premia. Nonetheless, under plausible parameterizations central-bank asset purchases have a fairly small impact on the yield curve by removing duration from the market, and these effects are particularly weak when interest rates are close to their zero lower bound.

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  • Thomas B. King, 2013. "A Portfolio-Balance Approach to the Nominal Term Structure," Working Paper Series WP-2013-18, Federal Reserve Bank of Chicago.
    • Handle: RePEc:fip:fedhwp:wp-2013-18
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    References listed on IDEAS

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    2. W. Arrata & B. Nguyen, 2017. "Price impact of bond supply shocks: Evidence from the Eurosystem's asset purchase program," Working papers 623, Banque de France.

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    More about this item

    Keywords

    Yield curve; LSAP; quantitative easing; preferred habitat forward guidance;
    All these keywords.

    JEL classification:

    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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