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Chinese Bond Market Challenges
Sergey N. Smirnov
State University Higher School of Economics Moscow
EFFAS-EBC meeting, June 2009 2
Contents:
1 Chinese Bonds Market Overview
3 Applying EFFAS-EBC methodology to Chinese Bonds Market
2 Zero-coupon yield curve used by CGSDTC
EFFAS-EBC meeting, June 2009 3
Market scale• About 3000 bonds with total worth 34 704,6
billion RMB issued since 1998
• Currently traded: 1385 bonds with outstanding amount 16 600 billion RMB (rmb usd rate:
1 Chinese yuan = 0.15 U.S. Dollars)
• About 1000 transactions a day with average daily turnaround about 150 billion RMB
• Bonds are traded at Shanghai and Shenzhen exchanges, OTC and inter-bank markets
EFFAS-EBC meeting, June 2009 4
Chinese Bonds Market Structure
Source: ChinaBond
EFFAS-EBC meeting, June 2009 5
Chinese Bonds Market Structure
Source: ChinaBond
EFFAS-EBC meeting, June 2009 6
Market Infrastructure
• The primary market of bond issuance is largely completed through syndication.
• Governmental bonds were mostly underwritten by the four stated-owned banks while other commercial banks and securities companies play active role in forming syndicate to market financial and corporate bonds.
• Most of bonds are held by banks, insurance companies, securities firms, and corporations. Mutual funds hold a relatively small fraction of the total outstanding bonds.
EFFAS-EBC meeting, June 2009 7
Instruments Present• Treasure Bonds (Ministry of Finance). All terms. Bullet redemption. Majority has coupons.
• Central Bank Bills (Peoples Bank of China). Very short and short term. Majority are discounted.
• Government owned BanksAll terms. Majority has coupons. Some have options.
• Corporate and Commercial Banks Bonds
• Others
EFFAS-EBC meeting, June 2009 8
Outstanding Amount
0
20000
40000
60000
80000
100000
120000
140000
160000
180000
10
0 m
illio
n R
MB
Treasure Bond Central Bank Bills Government owned banks Bonds Corporate Bonds Others
EFFAS-EBC meeting, June 2009 9
Current position:
1 Chinese Bonds Market Overview
3 Applying EFFAS-EBC methodology to Chinese Bonds Market
2 Zero-coupon yield curve used by CGSDTC
EFFAS-EBC meeting, June 2009 10
History of Zero-Coupon Yield Curves Development in China
• Research (1999-2001). With aid of Reuters was developed first yield curve for Treasure
bonds
• Prototypes (2002-2005). Chinese development of 4 yield curves for Treasure bonds using
information from different markets
• Exploitation and Modification (2006 - Present).
New methods are developed and yield curves are constructed for different types of bonds.
EFFAS-EBC meeting, June 2009 11
CGSDTC Methodology
• Data Filtering
• Expert and Historical Estimates
• Hermite Polynomial Fitting
EFFAS-EBC meeting, June 2009 12
Data Sources
• Deals Prices from Interbank, OTC and Shanghai Exchange markets
• Bid-Ask Quotes from Interbank market
• Market Participants estimates
EFFAS-EBC meeting, June 2009 13
Data Filtering
Visual comparison with historical yield curves, not historical market data
EFFAS-EBC meeting, June 2009 14
Expert and Historical Estimates
If too many entries are filtered out the data is augmented with expert estimates or historical
values
EFFAS-EBC meeting, June 2009 15
Hermite Polynomial Fitting
• Fix bonds maturity dates as grid nodes
• Fit Hermite polynomial such that:
a) Bond pricing equation holds
b) Yield expert estimates are recovered
EFFAS-EBC meeting, June 2009 16
Controversial results
EFFAS-EBC meeting, June 2009 17
Current position:
1 Chinese Bonds Market Overview
3 Applying EFFAS-EBC methodology to Chinese Bonds Market
2 Zero-coupon yield curve used by CGSDTC
EFFAS-EBC meeting, June 2009 18
Available data
Chinabond has kindly supplied us with the
following data:
– Daily trading results.
– Daily OTC Bid/Ask quotes from 8 banks.
EFFAS-EBC meeting, June 2009 19
Quotes co-Movement
EFFAS-EBC meeting, June 2009 20
Bid-Ask Spread co-Movement
EFFAS-EBC meeting, June 2009 21
Quotes: peculiarities
• Data contains errors: Bid > Ask
• Data is inconsistent: Bids>Askk for several days in a row
• Quoted YTM corresponds to smth slightly less than the Ask quote
• Bid-Ask spread is far too wide
• 4 banks quote all bonds, 4 banks quote only a subset.
EFFAS-EBC meeting, June 2009 22
“Best” inter-bank Bid-Ask spreads
EFFAS-EBC meeting, June 2009 23
Quotes: Yield Curves
EFFAS-EBC meeting, June 2009 24
Quotes: Forward Rates
EFFAS-EBC meeting, June 2009 25
Quotes: (Bid+Ask)/2
EFFAS-EBC meeting, June 2009 26
Quotes: Summary
• Different banks use different quoting schemes: the way quotes move differs a lot
• Either quotes are non-committing or banks are isolated from each other: systematic arbitrage is present
• Nobody uses spot forward rates
• Bonds are likely to be quoted in groups by time to maturity (duration is not used)
EFFAS-EBC meeting, June 2009 27
Prices: peculiarities
• Highly illiquid market
• Prices may lie well outside Bid/Ask quotes
• Similar bonds are frequently priced unlike each other
• No filtering helps since “unusual” prices tend to repeat in time
EFFAS-EBC meeting, June 2009 28
Number of Deals
EFFAS-EBC meeting, June 2009 29
Turnover
EFFAS-EBC meeting, June 2009 30
Price vs. Bid-Ask
EFFAS-EBC meeting, June 2009 31
Prices: Yield curves
EFFAS-EBC meeting, June 2009 32
More smoothing
EFFAS-EBC meeting, June 2009 33
High-Coupon Effect?
• Hypothesis: Chinese traders like high coupons (bonds with high coupons are valued higher).
• Testing: corr(coupon size, spread) = 10%
EFFAS-EBC meeting, June 2009 34
Visual Coupons
EFFAS-EBC meeting, June 2009 35
Prices: Summary
• Data from different sources are likely to be mixed
• Yield curves should be constructed from quotes
• Extremely illiquid market, price information is unreliable