Long-term Investors, Demand Shifts, and Yields

I use detailed data on bond and derivative positions of pension funds and insurance companies (P&Is) in the Netherlands to study demand shifts and their causal effect on yields. In particular, I exploit a reform in the regulatory discount curve that made the liabilities more sensitive to changes in the 20-year interest rate but less so to longer maturity rates. Following the reform, P&Is reduced their longest maturity holdings but increased those with maturities close to 20 years. The aggregate demand shift led to a steepening of the long-end of the yield curve with lower yields around 20-year maturities and higher yields at longer maturities. Similar effects on yields appear in a large panel of European countries after EU insurance regulations implemented the same regulatory reform. My findings have important policy implications, as they indicate that the regulatory framework of long-term investors directly affects the governments’ cost of borrowing.