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Chinese Bond Market Challenges

Chinese Bond Market Challenges

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Chinese Bond Market Challenges

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  1. Chinese Bond Market Challenges Sergey N. Smirnov State University Higher School of Economics Moscow

  2. 1 3 2 Contents: Chinese Bonds Market Overview Zero-coupon yield curve used by CGSDTC Applying EFFAS-EBC methodology to Chinese Bonds Market 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 Banks All terms. Majority has coupons. Some have options. • Corporate and Commercial Banks Bonds • Others EFFAS-EBC meeting, June 2009

  8. Outstanding Amount EFFAS-EBC meeting, June 2009

  9. 1 3 2 Current position: Chinese Bonds Market Overview Zero-coupon yield curve used by CGSDTC Applying EFFAS-EBC methodology to Chinese Bonds Market 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. 1 3 2 Current position: Chinese Bonds Market Overview Zero-coupon yield curve used by CGSDTC Applying EFFAS-EBC methodology to Chinese Bonds Market 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 EFFAS-EBC meeting, June 2009