Research (2)

Publications and work-in-progress.

2025.7.04

Dynamic Contagion Risk

2024.5.01

Preferred Habitats Across the Real and Nominal Term Structure of Interest Rates

ABSTRACT:

We develop a tractable model of the nominal and real term structure of interest rates based on the modern preferred habitat framework developed by Vayanos and Vila (2021). In our model, risk-averse arbitrageurs work to integrate both nominal and real yield curves over localised supply, while balancing their inflation and nominal short rate risk. Our model implies localised demand and supply between investors with preferences for specific maturities in one bond type can affect the equilibrium term structure of both inflation-protected and nominal assets. In order to evaluate our model empirically, we use a recursive vector auto-regression to identify shocks to model factors. Consistent with our theoretical predictions, we find evidence that cross-asset supply effects are positive and significant for real supply as measured by real weighted average maturity. In addition, the estimated coefficients for inflation and nominal short rates closely match their calibrated model counterparts.

AUTHOR:

Nimar C. Zhao

TOPICS:

Finance
Economics
Asset Pricing
Term Structure

PDF

@phdthesis{zhao_Preferred_2024,
  type = {Undergraduate {{Thesis}}},
  title = {Preferred {{Habitats Across}} the {{Nominal}} and {{Real Term Structure}} of {{Interest Rates}}},
  author = {Zhao, Nimar},
  year = 2024,
  month = may,
  abstract = {We develop a tractable model of the nominal and real term structure of interest rates based on the modern preferred habitat framework developed by Vayanos and Vila (2021). In our model, risk-averse arbitrageurs work to integrate both nominal and real yield curves over localised supply, while balancing their inflation and nominal short rate risk. Our model implies localised demand and supply between investors with preferences for specific maturities in one bond type can affect the equilibrium term structure of both inflation-protected and nominal assets. In order to evaluate our model empirically, we use a recursive vector auto-regression to identify shocks to model factors. Consistent with our theoretical predictions, we find evidence that cross-asset supply effects are positive and significant for real supply as measured by real weighted average maturity. In addition, the estimated coefficients for inflation and nominal short rates closely match their calibrated model counterparts.},
  langid = {english},
  school = {London School of Economics and Political Science},
  keywords = {Economics,Finance,Preferred Habitat,Term Structure}
}