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

EFFAS-EBC meeting, June 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 Market scale About 3000 bonds with total worth ,6 billion RMB issued since 1998 Currently traded: 1385 bonds with outstanding amount 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 Chinese Bonds Market Structure Source: ChinaBond

EFFAS-EBC meeting, June Chinese Bonds Market Structure Source: ChinaBond

EFFAS-EBC meeting, June 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 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 Outstanding Amount

EFFAS-EBC meeting, June 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 History of Zero-Coupon Yield Curves Development in China Research ( ). With aid of Reuters was developed first yield curve for Treasure bonds Prototypes ( ). Chinese development of 4 yield curves for Treasure bonds using information from different markets Exploitation and Modification ( Present). New methods are developed and yield curves are constructed for different types of bonds.

EFFAS-EBC meeting, June CGSDTC Methodology Data Filtering Expert and Historical Estimates Hermite Polynomial Fitting

EFFAS-EBC meeting, June Data Sources Deals Prices from Interbank, OTC and Shanghai Exchange markets Bid-Ask Quotes from Interbank market Market Participants estimates

EFFAS-EBC meeting, June Data Filtering Visual comparison with historical yield curves, not historical market data

EFFAS-EBC meeting, June 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 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 Controversial results

EFFAS-EBC meeting, June 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 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 Quotes co-Movement

EFFAS-EBC meeting, June Bid-Ask Spread co-Movement

EFFAS-EBC meeting, June Quotes: peculiarities Data contains errors: Bid > Ask Data is inconsistent: Bid s >Ask k 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 “Best” inter-bank Bid-Ask spreads

EFFAS-EBC meeting, June Quotes: Yield Curves

EFFAS-EBC meeting, June Quotes: Forward Rates

EFFAS-EBC meeting, June Quotes: (Bid+Ask)/2

EFFAS-EBC meeting, June 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 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 Number of Deals

EFFAS-EBC meeting, June Turnover

EFFAS-EBC meeting, June Price vs. Bid-Ask

EFFAS-EBC meeting, June Prices: Yield curves

EFFAS-EBC meeting, June More smoothing

EFFAS-EBC meeting, June 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 Visual Coupons

EFFAS-EBC meeting, June 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