Research Paper Search-for-Yield and Business Cycle

Oshima, Katsuhiro

9622017-02 , Institute of Economic Research, Kyoto University
Observing ultra-low interest yields in recent years, it is often pointed out that the existence of "search-for-yield" behaviors of financial institutions might have been intensifying interest rate drops. One hypothesis to explain "search-for-yield" is that banks try to buy longer-term bonds even when they expect upward paths of the short-term interest rate and they recognize negative term premium in long-term rates because they care about current portfolio income, not just expected holding-period returns. A main purpose of this paper is to study implications about general equilibrium effects from the existence of banks with this type of "search-for-yield". Hanson and Stein (2015) give explanations about what these investors bring to the long-term interest rate pricing from their partial equilibrium model. I incorporate a similar setting to theirs into a general equilibrium model with banks exposed to the value at risk constraint. Implications found here are as follows. First, the existence of these banks makes recovery path after negative productivity shock hits the economy more sluggish. Second, as Hanson and Stein (2015) suggest, we observe lower term premium in the long-term bond interest rate. Third, when the fiscal authority is more sensitive to the increase in bond outstanding, these impacts become smaller.

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