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By Robin M. Greenwood (Harvard Business School) & Annette Vissing-Jorgensen (National Bureau of Economic Research)
We document a strong effect of pension and insurance company (P&I) assets on the long end of the yield curve. Using data from 26 countries, the yield spread between 30-year and 10-year government bond yields is negatively related to the ratio of pension assets (in funded and private pension and life insurance arrangements) to GDP, suggesting that preferred-habitat demand by the P&I sector for long-dated assets drives the long end of the yield curve. We draw on changes in regulations in several European countries between 2008 and 2013 to provide well-identified evidence on the effect of the P&I sector on yields and to show that P&I demand is in part driven by hedging linked to the regulatory discount curve. When regulators reduce the dependence of the regulatory discount curve on a particular security, P&I demand for the security falls and its yield increases. We describe settings in which pension discount rules can have a destabilizing impact on bond markets.
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