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http://ssrn.com/abstract=2018540
 
 

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Preferred-Habitat and Demand Factors in the Term Structure: Evidence from the Chinese Bond Market


Longzhen Fan


Department of Finance, School of Management, Fudan University

Canlin Li


Federal Reserve Board

Guofu Zhou


Washington University in St. Louis - Olin School of Business

March 26, 2013


Abstract:     
Recent empirical studies suggest that demand and supply factors have important effects on bond yields. Both market segmentation and preferred habitat hypothesis are used to explain these demand and supply effects. In this paper, we use an affine preferred-habitat term structure model and the unique Chinese bond market data to study these two hypotheses. Chinese bond market is unique because there exists an official term structure of lending rates, set exogenously by the government, on preferred habitat investors' alternative investments on loans. We show that demands of both the preferred-habitat investors and the arbitrageurs affect bond yields and returns. Moreover, we also find that the preferred-habitat investors' alternative investment opportunities have expected effect on bond yields and returns. We further show that the preferred-habitat and demand factors improve bond pricing and return predictability in a no-arbitrage term structure model. Variance decomposition analysis shows that the preferred-habitat factor explains an important part of bond yield variations.

Number of Pages in PDF File: 37

Keywords: Preferred-habitat hypothesis, Market segmentation, Ocial interest rates, Bond demand, Affine term structure model

JEL Classification: E0, E4, G12, G10

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Date posted: March 12, 2012 ; Last revised: March 27, 2013

Suggested Citation

Fan, Longzhen and Li, Canlin and Zhou, Guofu, Preferred-Habitat and Demand Factors in the Term Structure: Evidence from the Chinese Bond Market (March 26, 2013). Available at SSRN: http://ssrn.com/abstract=2018540 or http://dx.doi.org/10.2139/ssrn.2018540

Contact Information

Longzhen Fan
Department of Finance, School of Management, Fudan University ( email )
Shanghai, 200433
China
86-21-2501-1093 (Phone)
86-21-6564-8384 (Fax)
HOME PAGE: http://www.fdsm.fudan.edu.cn/en/teacher/preview.aspx?uid=1794
Canlin Li
Federal Reserve Board ( email )
20th and C Streets, NW
Washington, DC 20551
United States
202-452-2227 (Phone)
Guofu Zhou (Contact Author)
Washington University in St. Louis - Olin School of Business ( email )
Washington University
Campus Box 1133
St. Louis, MO 63130-4899
United States
314-935-6384 (Phone)
314-658-6359 (Fax)
HOME PAGE: http://apps.olin.wustl.edu/faculty/zhou/
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