A Portfolio-Balance Approach to the Nominal Term Structure

45 Pages Posted: 14 Dec 2013 Last revised: 22 May 2015

See all articles by Thomas B. King

Thomas B. King

Federal Reserve Bank of Chicago

Date Written: January 31, 2015

Abstract

I examine how the maturity structure of outstanding government liabilities affects the nominal yield curve under a variety of assumptions about investor objectives. In the class of models I consider, equilibria are arbitrage free, expectations are rational, and assets are valued only for their pecuniary returns. Nonetheless, a portfolio-balance mechanism arises through the dependence of the pricing kernel on the return on wealth. This mechanism results in a positive relationship between the duration of bondholders' portfolios and the price of interest-rate risk. Quantitatively, the models suggest that the effects of shifting Treasury supply on yields can be substantial -- for example, the increase in the average maturity of U.S. government debt that occurred between 1976 and 1988 may have raised the ten-year yield by 50 basis points. On the other hand, partly reflecting an attenuation of portfolio-balance e¤ects when interest rates are near zero, the Federal Reserve's asset purchase programs likely had a fairly small impact on the yield curve by removing duration from the market.

Keywords: Yield curve, LSAP, asset purchase, Treasury supply, zero lower bound, quantitative easing, preferred habitat, forward guidance

JEL Classification: C63, E43, E44, E52, E58, G11, G12

Suggested Citation

King, Thomas B., A Portfolio-Balance Approach to the Nominal Term Structure (January 31, 2015). FRB of Chicago Working Paper No. 2013-18. Available at SSRN: https://ssrn.com/abstract=2366878 or http://dx.doi.org/10.2139/ssrn.2366878

Thomas B. King (Contact Author)

Federal Reserve Bank of Chicago ( email )

230 South LaSalle Street
Chicago, IL 60604
United States

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