Lin, William and Sun, David (2007): Liquidity-adjusted benchmark yield curves: a look at trading concentration and information. Published in: Review of Pacific Basin Financial Markets and Policies , Vol. 4, No. 10 (December 2007): pp. 491-518.
Download (532kB) | Preview
Estimation of benchmark yield curve in developing markets is often influenced by liquidity concentration. Based on an affine term structure model, we develop a long run liquidity weighted fitting method to address the trading concentration phenomenon arising from horizon-induced clientele equilibrium as well as information discovery. Specifically, we employ arguments from models of liquidity concentration and benchmark security information. After examining time series behavior of price errors against our fitted model, we find results consistent with both the horizon and information hypotheses. Our evidence indicates that trading liquidity carries information effect in the long run, which cannot be fully captured in the short run. Trading liquidity plays a key role in long run term structure fitting. Markets for liquid benchmark government bond issues collectively form a long term equilibrium. Compared with previous studies, our results provide a robust and realistic characterization of the spot rate term structure and related price forecasting over time, which in turn help portfolio investment of fixed income and long run pricing of financial instruments.
|Item Type:||MPRA Paper|
|Original Title:||Liquidity-adjusted benchmark yield curves: a look at trading concentration and information|
|Keywords:||liquidity, trading concentration, information discovery, term structure, yield curve|
|Subjects:||E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E43 - Interest Rates: Determination, Term Structure, and Effects
D - Microeconomics > D5 - General Equilibrium and Disequilibrium > D53 - Financial Markets
G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing ; Trading Volume ; Bond Interest Rates
D - Microeconomics > D4 - Market Structure, Pricing, and Design > D40 - General
D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D83 - Search ; Learning ; Information and Knowledge ; Communication ; Belief ; Unawareness
|Depositing User:||David Sun|
|Date Deposited:||11. Mar 2012 14:52|
|Last Modified:||12. Feb 2013 11:50|
Alonso, F., R. Blanco., A. Del Rio and A. Sanchis, “Estimating Liquidity Premia in Spanish Government Securities Market.” European Journal of Finance 10, 453-474, (December 2004).
Amihud, Y. and H. Mendelson, “Liquidity, Maturity, and the Yields on U.S Treasury Securities.” Journal of Finance 46(4), 1411-1425, (September 1991).
Bliss, R.R., “Testing Term Structure Estimation Methods.” Advances in Futures and Option Research 9, 197-232, ( June 1997).
Bolder, D.J. and D. Streliski, “Yield Curve Modelling at the Bank of Canada.” Bank of Canada Technical Report 84, (February 1999).
Darbha, G., “Estimating the Benchmark Yield Curve: A New Approach Using Stochastic Frontier Functions.” Working Paper, Rodney L. White Center for Financial Research, (March 2004)
Diaz, A., J. Merrick, Jr., and E. Navarro, “Spanish Treasury Bond Market Liquidity and Volatility pre- and post-European Monetary Union.” Journal of Banking and Finance 30, 1309-1332, (April 2006).
Diebold, F. and C. Li, “Forecasting the Term Structure of Government Bond Yields,” Journal of Econometrics 130(2), 337-364, (February 2006).
Duffee, G., “Term Premia and Interest Rate Forecasts in Affine Models.” Journal of Finance 57(1), 405-443, (February 2002).
Duffie, D. and K. Singleton, “An Econometric Model of the Term Structure of Interest-Rate Swap Yields.” Journal of Finance 52(4), 1287-1321, (September 1997).
Duffie, D, N. Garleanu, and L.H. Pedersen, “Over-The-Counter Markets.” Econometrica, 73(6), 1815-1847, (November 2005).
Dutta, G., S. Basu and K. Vaidyanathan, “Term Structure Estimation in Illiquid Government Bond Markets: An Empirical Analysis.” Journal of Emerging Market Finance 4, 63-80, (April 2005).
Elton, E.J. and T.C. Green, “Tax and Liquidity Effects in Pricing Government Bonds.” Journal of Finance, 53(5), 1532-1562, (October 1998).
Eom, Y., M. Subrahmanyam, and J. Uno, “Transmission of Swap Spreads and Volatilities in the Japanese Swap Market.” Journal of Fixed Income 12, 6-28, (June 2002).
Fisher, M., D. Nychka, and D. Zervos, “Fitting the Term Structure of Interest Rates with Smoothing Splines.” Working Paper, 95-1, Finance and Economics Discussion Series, Federal Reserve Board, (January 1995).
Fleming, M., “Measuring Treasury Market Liquidity.” FBNY Economic Policy Review 83-108, (September 2003).
Goldreich, D., B. Hanke, and P. Nath, “The Price of Future Liquidity: Time-Varying Liquidity in the US Treasury Market.” Review of Finance 9, 1-32, (March 2005).
Longstaff, F.A., “The Flight-To-Liquidity Premium in U.S. Treasury Bond Prices.” Journal of Business 77(3) 511-526, (July 2004)..
Liu, J., Longstaff, F.A., and R.E. Mandell, “The Market Price of Risk in Interest Rate Swaps: The Roles of Default and Liquidity Risks.” Journal of Business, 79(5), 2337-2359, (September 2006).
McCulloch, J.H., “Measure the Term Structure of Interest Rates.” Journal of Business, 44(1), 19-31, (January 1971).
Nelson, C.R. and A.F. Siegel, “Parsimonious Modeling of Yield Curves.” Journal of Business 60(4), 473-489, (October 1987).
Shen, P. and R.M. Starr, “Liquidity of the Treasury Bill Market and the Term Structure of Interest Rates.” Journal of Economics and Business 50(5), 401-417, (Septermber 1998).
Steeley, J.M., “Estimating the Gilt-Edged Term Structure: Basis Splines and Confidence Intervals.” Journal of Business Finance and Accounting, 18(4), 513-529, (June 1991).
Subramanian, K.V., “Term Structure Estimation in Illiquid Markets.” Journal of Fixed Income 11, 2, 77-86, (June 2001).
Svensson, L.O. “Estimating Forward Interest Rates with the Extended Nelson and Siegel Method.” Sveriges Riksbank Quarterly Review 3, 13-26, (September 1995).
Vayanos, D. and T. Wang, “Search and Endogenous Concentration of Liquidity in Asset Markets.” Journal of Economic Theory forthcoming, (2007).
Yuan, K., “The Liquidity Service of Benchmark Securities.” Journal of the European Economic Assosication 3(5), 1156-1180, (September 2005).
Waggoner, F.D., “Spline methods for extracting interest rate curves from coupon bond prices.” Working Paper 97-10, Federal Reserve Bank of Atlanta, (November 1997).