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Bond supply and excess bond returns

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We examine empirically how the maturity structure of government debt affects bond yields and excess returns. Our analysis is based on a theoretical model of preferred habitat in which clienteles with strong preferences for specific maturities trade with arbitrageurs. Consistent with the model, we find that (i) the supply of long- relative to short-term bonds is positively related to the term spread, (ii) supply predicts positively long-term bonds' excess returns even after controlling for the term spread and the Cochrane-Piazzesi factor, (iii) the e®ects of supply are stronger for longer maturities, and (iv) following periods when arbitrageurs have lost money, both supply and the term spread are stronger predictors of excess returns.

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en

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application/pdf

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http://eprints.lse.ac.uk/24425/1/dp607PWC2.pdf

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