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

59 Pages Posted: 9 Nov 2009 Last revised: 13 Nov 2009

See all articles by Dimitri Vayanos

Dimitri Vayanos

London School of Economics; Center for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Jean-Luc Vila

Merrill Lynch & Co.

Multiple version iconThere are 3 versions of this paper

Date Written: November 2009

Abstract

We model the term structure of interest rates as resulting from the interaction between investor clienteles with preferences for specific maturities and risk-averse arbitrageurs. Because arbitrageurs are risk averse, shocks to clienteles' demand for bonds affect the term structure---and constitute an additional determinant of bond prices to current and expected future short rates. At the same time, because arbitrageurs render the term structure arbitrage-free, demand effects satisfy no-arbitrage restrictions and can be quite different from the underlying shocks. We show that the preferred-habitat view of the term structure generates a rich set of implications for bond risk premia, the effects of demand shocks and of shocks to short-rate expectations, the economic role of carry trades, and the transmission of monetary policy.

Suggested Citation

Vayanos, Dimitri and Vila, Jean-Luc, A Preferred-Habitat Model of the Term Structure of Interest Rates (November 2009). NBER Working Paper No. w15487. Available at SSRN: https://ssrn.com/abstract=1501511

Dimitri Vayanos (Contact Author)

London School of Economics ( email )

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Center for Economic Policy Research (CEPR)

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National Bureau of Economic Research (NBER)

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Cambridge, MA 02138
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Jean-Luc Vila

Merrill Lynch & Co. ( email )

World Financial Center - North Tower
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New York, NY 10281-1319
United States

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