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Session Overview
APE-6: Term Structure I
Thursday, 24/Aug/2017:
10:30am - 12:00pm

Session Chair: Christian Heyerdahl-Larsen, London Business School
Location: O142

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Central Bank Communication and the Yield Curve

Matteo Leombroni1, Andrea Vedolin2, Gyuri Venter3, Paul Whelan3

1Stanford University; 2London School of Economics; 3Copenhagen Business School

Discussant(s): Paul Ehling (BI Norwegian Business School)

We decompose ECB monetary policy surprises into target and communication shocks and document a number of novel findings. First, consistent with the idea that concurrent implementation of monetary policy is largely anticipated, we find that target shocks only have a limited effect on yields. However, we show that communication shocks have a large and economically significant impact on sovereign yields, displaying a hump-shaped pattern across maturity. Second, we document that around the European debt crisis communication had the effect of driving a wedge between yields on core versus peripheral countries. We study two explanations for this finding, revelation of the ECB's private information and credit risk, and argue that neither channel can explain the effect on yield spreads. Motivated by this, we consider an alternative explanation in which central bank communication affects the aggregate demand due to the presence of reaching-for-yield investors. We show that a resulting risk premium channel helps to rationalize our findings.

EFA2017-1782-APE-6-Leombroni-Central Bank Communication and the Yield Curve.pdf

Information in (and not in) Treasury Options

Hoyong Choi

Erasmus University Rotterdam

Discussant(s): Philipp Illeditsch (University of Pennsylvania)

This paper studies the impact of variance risk in the Treasury market on both term premia and the shape of the yield curve. Under minimal assumptions shared by standard structural and reduced-form asset pricing models, I show that an observable proxy of variance risk in the Treasury market can be constructed via a portfolio of Treasury options. The observable variance risk has the ability to explain the time variation in term premia, but is largely unrelated to the shape of the yield curve. Using the observable variance risk, I also propose a new representation of no-arbitrage term structure models. All the pricing factors in the model are observable, tradable, and hence economically interpretable. The representation can also accommodate both unspanned macro risks and unspanned stochastic volatility in the term structure literature.

EFA2017-931-APE-6-Choi-Information in (and not in) Treasury Options.pdf

Explaining the Failure of the Expectations Hypothesis with Short-Term Rates

Angelo Ranaldo, Matthias Stephan Rupprecht

University of St. Gallen

Discussant(s): Philippe Mueller (London School of Economics)

This paper provides the first systematic study of the temporal and cross-sectional variation in the risk premium of the expectations hypothesis (EH) at very short end of the term structure. Using a unique and comprehensive dataset of European repurchase (repo) rates, we explain the sources and time variation affecting the risk premium. Our results show that the EH cannot be rejected when loans are secured by safe collateral and that unconventional monetary policy can substantially reduce risk premiums. By contrast, the EH is violated when interest rates are affected by funding risk and collateral risk.

EFA2017-428-APE-6-Ranaldo-Explaining the Failure of the Expectations Hypothesis with Short-Term Rates.pdf

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