Coupon Effects and the Pricing of Japanese Government Bonds: An Empirical Analysis
April 1998
Marti G. Subrahmanyam, Young Ho Eom, Jun Uno
ABSTRACT
In many markets, the term structure of interest rates implied by coupon Treasury bonds provides a key input for pricing and hedging interest rate-sensitive securities. Previous studies in the Japanese market, however, suggest that the prices of the Japanese Government Bonds (JGB's) were significantly affected modelling in the Japanese context bases on interest rate factors could leave to misleading results. Since the previous studies, there have been significant structural changes in the regulatory environment, and in the liquidity of the Japanese bond market in the 1990's. In this light, we examine the effect of these changes on the JGB prices during the period between 1990 and 1996, by analyzing the term structure of interest rates in the JGB market over time. Specifically, we use the B-spline method to fit the term structure of interest rates using weekly prices of "non-benchmark" ten-year JGB's. We also use a non-linear econometric model to examine the significance of the "coupon" effects, which are the results of regulatory, accounting and liquidity factors.
Our empirical analysis shows that it is possible to closely fit the term structure of interest rates in the JGB
market, with fitted price errors only slightly larger than those found in similar studies of the U.S. Treasury
bond market. Furthermore, the fitted price errors came somewhat muted over time. Our empirical results also indicate
that the coupon of the bond in the JGB market has a highly nonlinear effect on the prices due to the "par-bond"
effect and the "high-coupon" effect, although the "par-bond" effect is more pronounced in the
recent period. Further analysis shows that three factors (level, slope and curvature) explain a substantial proportion
of the results indicate that the efficiency of the JGB markets has improved over time. Hence, the time-series movement
of the JGB's can be captured to a substantial degree by common interest rate factors, although care should be taken
to incorporate the special characteristics of individual bonds.
Subrahmanyam: (212) 998-0348 msubrahm@stern.nyu.edu
To download a copy of this paper click here
To request a copy of this paper click here
The Finance Department Working Paper Series has been generously sponsored by