Abstract: This paper investigates the effect of purchases of U.S. Treasuries 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 prior to the financial crisis. Half of this change is explained by a drop in the termpremium: foreign purchases increase domestic agents’ consumption above their habit, reducing their risk-aversion and decreasing the term-premium. Finally, I show that a reversal of foreign inflows results in a sharp increase in long-term yields.
Keywords: term-premium, long-term yields, U.S. Treasury bonds, habits.
JEL: E43, E44, G12, G15