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  • August 2021
  • Article
  • Quarterly Journal of Economics

Rate-Amplifying Demand and the Excess Sensitivity of Long-Term Rates

By: Samuel G. Hanson, David O. Lucca and Jonathan H. Wright
  • Format:Print
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Abstract

Long-term nominal interest rates are surprisingly sensitive to high-frequency (daily or monthly) movements in short-term rates. Since 2000, this high-frequency sensitivity has grown even stronger in U.S. data. By contrast, the association between low-frequency changes (at 6- or 12-month horizons) in long- and short-term rates, which was also strong before 2000, has weakened substantially. This puzzling post-2000 pattern arises because increases in short rates temporarily raise the term premium component of long-term yields, leading long rates to temporarily overreact to changes in short rates. The frequency-dependent excess sensitivity of long-term rates that we observe in recent years is best understood using a model in which (i) declines in short rates trigger "rate-amplifying" shifts in investor demand for long-term bonds and (ii) the arbitrage response to these demand shifts is both limited and slow. We study, both theoretically and empirically, how such rate-amplifying demand can be traced to mortgage refinancing activity, investors who extrapolate recent changes in short rates, and investors who "reach for yield" when short rates fall. We discuss the implications of our findings for the validity of event-study methodologies and the transmission of monetary policy.

Keywords

Conundrum; Investor Demand; Monetary Policy Transmission; Interest Rates

Citation

Hanson, Samuel G., David O. Lucca, and Jonathan H. Wright. "Rate-Amplifying Demand and the Excess Sensitivity of Long-Term Rates." Quarterly Journal of Economics 136, no. 3 (August 2021): 1719–1781.

Supplemental Information

Internet Appendix
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About The Author

Samuel G. Hanson

Finance
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  • Predictable Financial Crises By: Robin Greenwood, Samuel G. Hanson, Andrei Shleifer and Jakob Ahm Sørensen
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