Using a large panel of Treasury futures and options, this study constructs model-free measures of bond uncertainty and tail risks. The author mainly studies the behavior of bond risk measures around FOMC announcements and document three novel findings. First, bond uncertainty risk displays a rise and resolution similar to the stock VIX index, while tail risks don’t respond to announcements. Second, pre-FOMC announcement drift exists in terms of Treasury yields declining by 1 bps on the day before the announcement. Third, option-implied uncertainty cannot help explain the pre-FOMC announcement drift.
{"title":"Bond Implied Risks around Macroeconomic Announcements","authors":"Xinyang Li","doi":"10.3905/jfi.2023.1.167","DOIUrl":"https://doi.org/10.3905/jfi.2023.1.167","url":null,"abstract":"Using a large panel of Treasury futures and options, this study constructs model-free measures of bond uncertainty and tail risks. The author mainly studies the behavior of bond risk measures around FOMC announcements and document three novel findings. First, bond uncertainty risk displays a rise and resolution similar to the stock VIX index, while tail risks don’t respond to announcements. Second, pre-FOMC announcement drift exists in terms of Treasury yields declining by 1 bps on the day before the announcement. Third, option-implied uncertainty cannot help explain the pre-FOMC announcement drift.","PeriodicalId":53711,"journal":{"name":"Journal of Fixed Income","volume":"89 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2023-08-17","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"136215210","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Musa Amadeus, R. Bhargava, M. Guidi, Marvin Loh, Gideon Ozik, Ronnie Sadka
Amadeus et al. (2022) observe that aggregated, consensus (top-down) central bank monetary tones in media contain predictive information pertaining to future weekly yield fluctuations. This article elucidates the more granular, stratified (bottom-up) dynamics underlying these relations. The predictive relationships between Fed consensus tones and yields are primarily driven by an underreaction of yields to the Fed Board of Governors’ tones between monetary policy meetings. Over short-term horizons, Treasury yields appear to price voting FOMC members’ (Board of Governors’ and Regional Bank Presidents’) tones while relatively longer-term horizon yields appear to reflect both voting and non-voting tones. Fed Regional Bank Presidents’ monetary tones are more responsive to regional inflation fluctuations than to unemployment. The analysis of the heterogeneous impacts of Fed members’ tones over distinct yield horizons provides insights pertaining to the pricing of voting and non-voting Fed members’ tones in Treasury markets.
{"title":"Fed Members’ Monetary Tones and Yields","authors":"Musa Amadeus, R. Bhargava, M. Guidi, Marvin Loh, Gideon Ozik, Ronnie Sadka","doi":"10.3905/jfi.2023.1.166","DOIUrl":"https://doi.org/10.3905/jfi.2023.1.166","url":null,"abstract":"Amadeus et al. (2022) observe that aggregated, consensus (top-down) central bank monetary tones in media contain predictive information pertaining to future weekly yield fluctuations. This article elucidates the more granular, stratified (bottom-up) dynamics underlying these relations. The predictive relationships between Fed consensus tones and yields are primarily driven by an underreaction of yields to the Fed Board of Governors’ tones between monetary policy meetings. Over short-term horizons, Treasury yields appear to price voting FOMC members’ (Board of Governors’ and Regional Bank Presidents’) tones while relatively longer-term horizon yields appear to reflect both voting and non-voting tones. Fed Regional Bank Presidents’ monetary tones are more responsive to regional inflation fluctuations than to unemployment. The analysis of the heterogeneous impacts of Fed members’ tones over distinct yield horizons provides insights pertaining to the pricing of voting and non-voting Fed members’ tones in Treasury markets.","PeriodicalId":53711,"journal":{"name":"Journal of Fixed Income","volume":"33 1","pages":"6 - 16"},"PeriodicalIF":0.0,"publicationDate":"2023-08-14","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"41656727","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
This article shows that virtually all the empirical features associated with the predictability of conditional and unconditional excess returns in Treasuries (USD and EUR) can be simply and convincingly explained by an extremely parsimonious model of the joint actions of rational monetary authorities and cognitively biased (“overrepresentative”) investors. With their model, the authors explain and recover, at a quantitative level, the Sharpe ratios of conditional and unconditional strategies, the business-cycle dependence of the profitability of these strategies, the predictability afforded by inflation surprises, the periodicities of the Cieslak-Povala cycles, the patterns of the Cochrane-Piazzesi return-predicting factors, and the term structure of correlation between EH-predicted and realized yield changes. They argue that the explanation for return predictability in Treasuries they offer is simpler than, and at least as empirically compelling as, the more traditional asset-pricing-based explanations.
{"title":"Can Representativeness Explain the Predictability of Treasury Bonds Returns?","authors":"R. Rebonato, R. Ronzani, Dimitri Tronson","doi":"10.3905/jfi.2023.1.165","DOIUrl":"https://doi.org/10.3905/jfi.2023.1.165","url":null,"abstract":"This article shows that virtually all the empirical features associated with the predictability of conditional and unconditional excess returns in Treasuries (USD and EUR) can be simply and convincingly explained by an extremely parsimonious model of the joint actions of rational monetary authorities and cognitively biased (“overrepresentative”) investors. With their model, the authors explain and recover, at a quantitative level, the Sharpe ratios of conditional and unconditional strategies, the business-cycle dependence of the profitability of these strategies, the predictability afforded by inflation surprises, the periodicities of the Cieslak-Povala cycles, the patterns of the Cochrane-Piazzesi return-predicting factors, and the term structure of correlation between EH-predicted and realized yield changes. They argue that the explanation for return predictability in Treasuries they offer is simpler than, and at least as empirically compelling as, the more traditional asset-pricing-based explanations.","PeriodicalId":53711,"journal":{"name":"Journal of Fixed Income","volume":"33 1","pages":"17 - 49"},"PeriodicalIF":0.0,"publicationDate":"2023-08-09","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"42973128","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Credit spreads behavior displays a range of features that are challenging to model—strongly fat-tailed distribution of changes, periods of relative stability interrupted by prolonged violent shifts, lack of symmetry in spread rises vs. falls, etc. This article proposes a new model for spread behavior that incorporates these peculiarities without bringing excessive mathematical complexity. At the core of our approach is a Hidden Markov Model (HMM) that assumes that spreads follow a 2-state stochastic process. In a key departure from traditional HMM, the authors introduce explicit auto-regression into their formulation. The assumption behind that innovation is that while regime switches may be instantaneous and regimes may be characterized by different spread “fair” levels, the transition between such levels is gradual as opposed to instantaneous. As they illustrate, this assumption is critical for proper description of the spreads dynamic. The model lends itself well to tactical asset allocation involving high-yield credit assets and in a broad, multi-asset class setting.
{"title":"Modeling Credit Spreads through Regime Switching with Gradual Transition","authors":"Pravesh Kumar, Rahul Sathyajit, Alexander Rudin","doi":"10.3905/jfi.2023.1.164","DOIUrl":"https://doi.org/10.3905/jfi.2023.1.164","url":null,"abstract":"Credit spreads behavior displays a range of features that are challenging to model—strongly fat-tailed distribution of changes, periods of relative stability interrupted by prolonged violent shifts, lack of symmetry in spread rises vs. falls, etc. This article proposes a new model for spread behavior that incorporates these peculiarities without bringing excessive mathematical complexity. At the core of our approach is a Hidden Markov Model (HMM) that assumes that spreads follow a 2-state stochastic process. In a key departure from traditional HMM, the authors introduce explicit auto-regression into their formulation. The assumption behind that innovation is that while regime switches may be instantaneous and regimes may be characterized by different spread “fair” levels, the transition between such levels is gradual as opposed to instantaneous. As they illustrate, this assumption is critical for proper description of the spreads dynamic. The model lends itself well to tactical asset allocation involving high-yield credit assets and in a broad, multi-asset class setting.","PeriodicalId":53711,"journal":{"name":"Journal of Fixed Income","volume":"33 1","pages":"98 - 110"},"PeriodicalIF":0.0,"publicationDate":"2023-07-19","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"48550046","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
This article presents a finite difference approach to a pull-to-par model for call and put options on zero-coupon bonds. The original solution was asymptotic and for European-styled options on bonds without coupons. As the asymptotic solution is an approximation to the true solution, the finite difference approach provides an easy alternative to estimating the true value. In addition, the finite difference approach presented here easily allows for the addition of coupons and American style pricing. The authors provide error rates vs. the original solution and illustrate values for options on bonds with coupons.
{"title":"Option Pricing with Finite Difference Using a Pull-to-Par Bond Model","authors":"Michael J. Tomas, Jun Yu","doi":"10.3905/jfi.2023.1.163","DOIUrl":"https://doi.org/10.3905/jfi.2023.1.163","url":null,"abstract":"This article presents a finite difference approach to a pull-to-par model for call and put options on zero-coupon bonds. The original solution was asymptotic and for European-styled options on bonds without coupons. As the asymptotic solution is an approximation to the true solution, the finite difference approach provides an easy alternative to estimating the true value. In addition, the finite difference approach presented here easily allows for the addition of coupons and American style pricing. The authors provide error rates vs. the original solution and illustrate values for options on bonds with coupons.","PeriodicalId":53711,"journal":{"name":"Journal of Fixed Income","volume":"33 1","pages":"129 - 139"},"PeriodicalIF":0.0,"publicationDate":"2023-07-18","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"45790603","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Pub Date : 2023-06-30DOI: 10.3905/jfi.2023.33.1.001
Stanley J. Kon
{"title":"Editor’s Letter","authors":"Stanley J. Kon","doi":"10.3905/jfi.2023.33.1.001","DOIUrl":"https://doi.org/10.3905/jfi.2023.33.1.001","url":null,"abstract":"","PeriodicalId":53711,"journal":{"name":"Journal of Fixed Income","volume":"33 1","pages":"1"},"PeriodicalIF":0.0,"publicationDate":"2023-06-30","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"41484736","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Bond portfolio managers constantly worry about the liquidity of their portfolio. Consider a bond portfolio manager holding bonds of a particular firm that has numerous maturities outstanding. Assume that some of the issuing firm’s bonds mature. Do the firm’s remaining bonds become more liquid or less liquid? The authors analyze the impact of the maturity of a firm’s bonds on the liquidity of the firm’s remaining bonds, where a reduction in the number of bonds outstanding suggests a potential reduction in liquidity. Alternatively, the leverage reduction due to the reduction in the number of bonds outstanding may improve the firm’s credit quality and result in greater liquidity. Their results strongly suggest the former where the strength of reduction depends on the ratio of the USD amount matured to total debt. The results have important implications for how to hedge the portfolio against interest changes.
{"title":"What Happens to Bond Liquidity When Some Bonds of the Issuer Mature?","authors":"Duane R. Stock, Runzu Wang","doi":"10.3905/jfi.2023.1.162","DOIUrl":"https://doi.org/10.3905/jfi.2023.1.162","url":null,"abstract":"Bond portfolio managers constantly worry about the liquidity of their portfolio. Consider a bond portfolio manager holding bonds of a particular firm that has numerous maturities outstanding. Assume that some of the issuing firm’s bonds mature. Do the firm’s remaining bonds become more liquid or less liquid? The authors analyze the impact of the maturity of a firm’s bonds on the liquidity of the firm’s remaining bonds, where a reduction in the number of bonds outstanding suggests a potential reduction in liquidity. Alternatively, the leverage reduction due to the reduction in the number of bonds outstanding may improve the firm’s credit quality and result in greater liquidity. Their results strongly suggest the former where the strength of reduction depends on the ratio of the USD amount matured to total debt. The results have important implications for how to hedge the portfolio against interest changes.","PeriodicalId":53711,"journal":{"name":"Journal of Fixed Income","volume":"33 1","pages":"43 - 56"},"PeriodicalIF":0.0,"publicationDate":"2023-06-20","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"47714835","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
The authors present a new estimation method for the “natural” interest rate and estimate its value for the US economy from 1961 to 2020. Presuming theoretical balance between returns on national assets and cost of national capital, the authors use US balance sheet information to derive a “breakeven” or implicit fundamental risk-free rate. Because, unlike r-star (r*), our rate does not presume conditions of full employment, its value should generally be lower than that of r*. The authors find, however, that our rate has remained above r* for much of the past 25 years, suggesting that the Federal Reserve’s accommodative policy for the past two decades has been more aggressive than previously believed. Understanding the difference between our natural rate, r*, and current market rates is critical for proper decisions in the fixed income markets.
{"title":"A National Balance Sheet Approach to the Natural Rate of Interest","authors":"Robert S. Goldberg, M. Torras","doi":"10.3905/jfi.2023.1.161","DOIUrl":"https://doi.org/10.3905/jfi.2023.1.161","url":null,"abstract":"The authors present a new estimation method for the “natural” interest rate and estimate its value for the US economy from 1961 to 2020. Presuming theoretical balance between returns on national assets and cost of national capital, the authors use US balance sheet information to derive a “breakeven” or implicit fundamental risk-free rate. Because, unlike r-star (r*), our rate does not presume conditions of full employment, its value should generally be lower than that of r*. The authors find, however, that our rate has remained above r* for much of the past 25 years, suggesting that the Federal Reserve’s accommodative policy for the past two decades has been more aggressive than previously believed. Understanding the difference between our natural rate, r*, and current market rates is critical for proper decisions in the fixed income markets.","PeriodicalId":53711,"journal":{"name":"Journal of Fixed Income","volume":"33 1","pages":"106 - 119"},"PeriodicalIF":0.0,"publicationDate":"2023-05-12","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"47971825","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Yalin Gündüz, Loriana Pelizzon, Michael Schneider, Marti G. Subrahmanyam
We study market liquidity in the markets for German and US corporate bonds, providing a comparative analysis of liquidity in two over-the-counter (OTC) bond markets with different characteristics. We employ a unique regulatory dataset of transactions by German financial institutions from 2008 to 2014 to find, first, that overall trading activity is much lower in the German market than in the US. Second, much like in the US, the determinants of German corporate bond liquidity are in line with OTC-market search theories. Third—and surprisingly—frequently traded German bonds have transaction costs that are 39–61 basis points lower than a matched sample of bonds in the US. We relate our results to a number of structural market differences that may explain our findings, including differences in market structure, transparency, and the tax and legal environment.
{"title":"Lighting Up the Dark: Liquidity in the German Corporate Bond Market","authors":"Yalin Gündüz, Loriana Pelizzon, Michael Schneider, Marti G. Subrahmanyam","doi":"10.3905/jfi.2023.1.160","DOIUrl":"https://doi.org/10.3905/jfi.2023.1.160","url":null,"abstract":"We study market liquidity in the markets for German and US corporate bonds, providing a comparative analysis of liquidity in two over-the-counter (OTC) bond markets with different characteristics. We employ a unique regulatory dataset of transactions by German financial institutions from 2008 to 2014 to find, first, that overall trading activity is much lower in the German market than in the US. Second, much like in the US, the determinants of German corporate bond liquidity are in line with OTC-market search theories. Third—and surprisingly—frequently traded German bonds have transaction costs that are 39–61 basis points lower than a matched sample of bonds in the US. We relate our results to a number of structural market differences that may explain our findings, including differences in market structure, transparency, and the tax and legal environment.","PeriodicalId":53711,"journal":{"name":"Journal of Fixed Income","volume":"294 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2023-03-31","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"135731448","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Pub Date : 2023-03-31DOI: 10.3905/jfi.2023.32.4.001
Stanley J. Kon
{"title":"Editor’s Letter","authors":"Stanley J. Kon","doi":"10.3905/jfi.2023.32.4.001","DOIUrl":"https://doi.org/10.3905/jfi.2023.32.4.001","url":null,"abstract":"","PeriodicalId":53711,"journal":{"name":"Journal of Fixed Income","volume":"32 1","pages":"1"},"PeriodicalIF":0.0,"publicationDate":"2023-03-31","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"46126716","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
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