Impact of Asset Purchases on the Bond Market
Draft available soon. I study the impact of asset purchases on the composition of institutional bondholders’ portfolios and how this acts as a transmission mechanism for quantitative easing: As the price of assets targeted by the purchases rises, investors search for yield and purchase untargeted assets, pushing up their price. I propose a mechanism where institutional bondholders take advantage of financial frictions before this policy transmission occurs. When asset purchases increase, institutional bondholders will first build up an inventory of specific bonds targeted by the purchases, diminishing the bonds’ available free float to squeeze out a profit from the Central Banks buying up the bonds. In a second phase, as prices for targeted assets stabilize, institutional bondholders will rebalance their portfolio towards bonds untargeted by the purchases as they search for yield, thereby transmitting quantitative easing to untargeted markets.