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Publicado en: Documento de trabajo

Addicted to Debt: Foreign Purchases of U.S. Treasuries and the Term Premium

David Kohn.

Documento de Trabajo IE-PUC, N° 480, 2016

This paper investigates the effect of purchases of U.S. Treasury bonds by foreigners on long-term yields and the term-premium. I set up a consumption-based model with habit preferences, calibrate it to match the average slope of the yield curve in the U.S., and find that foreign purchases decreased long-term yields significantly over the period prior to the financial crisis. Half of this change is explained by a drop in the term-premium: in the model, foreign purchases increase domestic agents’ consumption above their habit, thus reducing their risk-aversion and decreasing the term-premium. Finally, I investigate the potential impact of a sell-off of U.S. Treasuries by foreigners. I show that such a reversal of foreign inflows would result in a sharp increase in the term-premium and, thus, in long-term yields.

Keywords: term-premium, long-term yields, U.S. Treasury bonds, habits.

JEL Classification: E43, E44, G12, G15


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