Forward Guidance in the Yield Curve: Short Rates versus Bond Supply

Robin Greenwood, Samuel Hanson, Dimitri Vayanos

NBER Working Paper No. 21750
Issued in December 2015
NBER Program(s): AP ME

We present a model of the yield curve in which the central bank can provide market participants with forward guidance on both future short rates and on future Quantitative Easing (QE) operations, which affect bond supply. Forward guidance on short rates works through the expectations hypothesis, while forward guidance on QE works through expected future bond risk premia. If a QE operation is expected to be undone in the near term, then its announcement will have a hump-shaped effect on the yield and forward-rate curves; otherwise the effect may be increasing with maturity. Humps associated to QE announcements typically occur at maturities longer than those associated to short-rate announcements, even when the effects of the former are expected to last over a shorter horizon. We use our model to re-examine the empirical evidence on QE announcements in the US.

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Robin Greenwood

George Gund Professor of Finance and Banking

Robin is the George Gund Professor of Finance and Banking at Harvard Business School. He works in behavioral and institutional finance, with a particular focus on "macro-level" market inefficiencies. He received a Ph.D. from Harvard in Economics, and B.S. degrees in Economics and Mathematics at MIT. He has taught in both years of the MBA curriculum as well as the PhD. program. He was the chair of the Finance for Senior Executives Program, developed the Behavioral and Value Investing Elective Course, and now runs the first semester of finance in the MBA program. He is a Research Associate at the National Bureau of Economic Research and an editor of the Review of Financial Studies.

http://www.hbs.edu/faculty/Pages/profile.aspx?facId=136446

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