Supply and Demand and the Term Structure of Interest Rates

We survey the growing literature emphasizing the role that supply-and-demand forces play in shaping the term structure of interest rates. Our starting point is the Vayanos and Vila (2009, 2021) model of the term structure of default-free bond yields, which we present in both discrete and continuous time. The key friction in the model is that the bond market is partially segmented from other financial markets: the prices of short-rate and bond supply risk are set by specialized bond arbitrageurs who must absorb shocks to the supply and demand for bonds from other "preferred-habitat" agents. We discuss extensions of this model in the context of default-free bonds and other asset classes