Abstract
Previous research has emphasized the portfolio balance effects of Federal Reserve bond purchases, in which a reduced bond supply lowers term premia. In contrast, we find that such purchases have important signaling effects that lower expected future shortterm interest rates. Our evidence comes from a model-free analysis and from dynamic term structure models that decompose declines in yields following Fed announcements into changes in risk premia and expected short rates. To overcome problems in measuring term premia, we consider bias-corrected model estimation and restricted risk price estimation. We also characterize the estimation uncertainty regarding the relative importance of the signaling and portfolio balance channels.
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