Monetary Policy, Institutional Investors, and Bond Markets
Paper Session
Friday, Jan. 6, 2023 8:00 AM - 10:00 AM (CST)
- Chair: Motohiro Yogo, Princeton University
Long-term Investors, Demand Shifts, and Yields
Abstract
I use detailed data on bond and swap positions of pension funds and insurance companies (P&Is) in the Netherlands to study demand shifts and their causal effect on government bond yields. In particular, I exploit a reform in the regulatory discount curve that makes liabilities more sensitive to changes in the 20-year interest rate but less so to longer maturity rates. Following the reform, P&Is reduced their longest maturity holdings but increased those with maturities close to 20 years. The aggregate demand shift caused a substantial steepening of the long-end of the yield curve. Using the regulatory reform as an exogenous shock to estimate the demand elasticities of various investors in the government bond market, I show that the banking sector is most price elastic and primarily responsible for absorbing demand shocks. My findings indicate that the regulatory framework of long-term investors spills over to other sectors and directly affects the governments' cost of borrowing.Who Holds Sovereign Debt and Why It Matters
Abstract
The behavior of the investors in sovereign debt can have important implications for the ability of governments to borrow during distress periods, such as the on-going Covid crisis. To study this issue, we construct an aggregate data set of sovereign debt holdings by foreign and domestic investors, further disaggregated into banks and non-bank private, and official investors for 95 countries over twenty years. Analyzing these holdings leads to several important findings. First, increases in the outstanding supply of sovereign debt is largely absorbed by private non-bank investors. Per additional unit of debt, these nonbank investors absorb 69% despite accounting for only 46% of the outstanding amounts on average. Utilizing a more granular data set of euro area investors, we find that investment funds play the largest role among private non-bank investors, rather than insurance and pension funds or non-financial investors. Second, many countries tend to have a dominant investor group, and each investor group exhibits distinct behavior with respect to local and global factors. For global shocks, non-bank investors tend to react similarly whether they are foreign or domestic, whereas banks react distinctly along those lines. Finally, for the sovereign debt of emerging markets (EMs), we estimate investor demand functions using a market-clearing identification. Implied counterfactual analysis shows that an increase in debt for an average EM country will lead to a proportionally higher increase in borrowing costs across their overall creditors, but an out-sized increase if private non-bank investors disappear. Taken together, our analysis suggests that EM sovereign borrowing is highly vulnerable to non-bank investors such as hedge funds and mutual funds.Granular Investors and International Bond Prices: Scarcity Induced Safety
Abstract
Institutional investors' mandates determine bond demand, which, through granularity, affects bond prices. Leveraging on a unique dataset that includes all corporate bonds held by euro-area investors, we explore the impact of investor's demand on currency pricing. Institutional investors have different mandates, with insurance and pension funds exhibiting home asset and currency biases, and mutual funds displaying neither. This neat segmentation, alongside the fact that our investors are subject to the same monetary policy, motivates our identification strategy. We estimate, in a currency hedged and unhedged specifications, investors’ residual in euro-dollar yield differentials for the same security and issuer, and for investors facing the same monetary stance. The euro-dollar residual differential declines during our sample period, indicating an erosion of dollar convenience yields. This suggests that the scarcity of euro bonds induced by ECB asset purchases against the rising demand of those assets by insurance and pension funds produced the decline. The ensuing fall in duration risk, in turn, induces those investors to rebalance their portfolio weights toward euro assets. A model of optimal portfolio choice by institutional investors can explain the time- varying residual, through the heterogeneous loss-averse preferences of their clients.JEL Classifications
- E44 - Financial Markets and the Macroeconomy
- G12 - Equities; Fixed Income Securities