Preferred-Habitat and Demand Factors in the Term Structure: Evidence from the Chinese Bond Market

Abstract

Recent empirical studies suggest that demand and supply factors have important eects on bond yields. Both market segmentation and preferred habitat hypothesis are used to explain these demand and supply eects. In this paper, we use an ane preferred-habitat term structure model and the unique Chinese bond market data to study these two hypotheses. Chinese bond market is unique because there exists an ocial term structure of lending rates, set exogenously by the government, on preferred habitat investors’ alternative investments of loans. We show that demands of both the preferred-habitat investors and the arbitrageurs aect bond yields and returns. Moreover, we also nd that the preferred-habitat investors’ alternative investment opportunities have expected eect on bond yields and returns. We further show that