The Excess Sensitivity of Long-Term Rates: A Tale of Two Frequencies

78 Pages Posted: 31 Mar 2017

See all articles by Samuel Gregory Hanson

Samuel Gregory Hanson

Harvard Business School

David O. Lucca

Federal Reserve Banks - Federal Reserve Bank of New York

Jonathan H. Wright

Johns Hopkins University - Department of Economics

Date Written: October 1, 2018

Abstract

Long-term nominal interest rates are known to be highly sensitive to high-frequency (daily or monthly) movements in short-term rates. We find that, since 2000, this high-frequency sensitivity has grown even stronger in U.S. data. By contrast, the association between low-frequency changes (at six- or twelve-month horizons) in short- and long-term rates, which was also strong before 2000, has weakened substantially. We show that this puzzling post-2000 combination of high-frequency “excess sensitivity” and low-frequency “decoupling” of short- and long-term rates arises because increases in short rates temporarily raise the term premium on long-term bonds, leading long rates to temporarily overreact to changes in short rates. The post-2000 frequency-dependent sensitivity of long-term rates can be understood using a model in which (i) declines in short rates lead to outward shifts in the demand for long-term bonds (for example, because some investors “reach for yield”) and (ii) the arbitrage response to these demand shifts is slow. We discuss the implications of our findings for the transmission of monetary policy and the validity of the event-study methodologies.

Keywords: interest rates, conundrum, monetary policy transmission

JEL Classification: E43, E52, G12

Suggested Citation

Hanson, Samuel Gregory and Lucca, David O. and Wright, Jonathan H., The Excess Sensitivity of Long-Term Rates: A Tale of Two Frequencies (October 1, 2018). FRB of NY Staff Report No. 810. Available at SSRN: https://ssrn.com/abstract=2943920

Samuel Gregory Hanson (Contact Author)

Harvard Business School ( email )

Soldiers Field Road
Morgan 270C
Boston, MA 02163
United States

David O. Lucca

Federal Reserve Banks - Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States

Jonathan H. Wright

Johns Hopkins University - Department of Economics ( email )

3400 Charles Street
Baltimore, MD 21218-2685
United States

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