The term structure of interest rate and bond supply

Abstract

Only recently, after the macroeconomic stability, it was possible to study the proprieties of Brazilian term structure of interest rate. A better understanding of the term structure dynamic determinants is necessary due to economic policy considerations. There are two opposite approach to model term structure. The first one states that long rate are a weighted average of short rate plus a term premium and no arbitrage is possible between these differences. The second view states that the agents do have preferences for particular maturities only and this is the main reason why long and short term rates are disconnected. This paper test the propositions developed by Greenwood and Vayanos (2008) from a formal model in which the government reacts supplying bonds as a function of the market prices. In this model the duration of the public debt is related to term structure premium. The aim of the present paper is to test if the average maturity of the public debt bonds affects both the excess return spreads in the term structure curve. The results shows that the debt maturity is related to spreads and excess returns. The effect is stronger in the second case.