Supply and Demand and the Term Structure of Interest Rates

49 Pages Posted: 20 Nov 2023 Last revised: 8 Feb 2025

See all articles by Robin M. Greenwood

Robin M. Greenwood

Harvard Business School - Finance Unit; National Bureau of Economic Research (NBER)

Samuel Gregory Hanson

Harvard University - Business School (HBS)

Dimitri Vayanos

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

Date Written: November 2023

Abstract

We survey the growing literature emphasizing the role that supply-and-demand forces play in shaping the term structure of interest rates. Our starting point is the Vayanos and Vila (2009, 2021) model of the term structure of default-free bond yields, which we present in both discrete and continuous time. The key friction in the model is that the bond market is partially segmented from other financial markets: the prices of short-rate and bond supply risk are set by specialized bond arbitrageurs who must absorb shocks to the supply and demand for bonds from other “preferred-habitat” agents. We discuss extensions of this model in the context of default-free bonds and other asset classes.

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Suggested Citation

Greenwood, Robin M. and Hanson, Samuel Gregory and Vayanos, Dimitri, Supply and Demand and the Term Structure of Interest Rates (November 2023). NBER Working Paper No. w31879, Available at SSRN: https://ssrn.com/abstract=4638213

Robin M. Greenwood (Contact Author)

Harvard Business School - Finance Unit ( email )

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Samuel Gregory Hanson

Harvard University - Business School (HBS) ( email )

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Dimitri Vayanos

London School of Economics ( email )

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Center for Economic Policy Research (CEPR)

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