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Extracting Market Expectations on the Duration of the Zero Interest Rate Policy from Japan's Bond Prices

Author

Listed:
  • Kohei Marumo

    (Bank of Japan)

  • Takashi Nakayama

    (Bank of Japan)

  • Shinichi Nishioka

    (Bank of Japan)

  • Toshihiro Yoshida

    (Bank of Japan)

Abstract

This paper aims to extract the expectations of market participants on the duration of the Zero Interest Rate Policy (ZIRP) by the Bank of Japan by modeling the term structure of interest rates. Under the ZIRP, particularly the short-term and medium-term interest rates are so low that we face difficulty applying traditional yield curve models such as the Vasicek model to them. This circumstance motivated us to model the expectations of market participants on the duration of the ZIRP by regarding it as one of the risk factors of a yield curve. To be specific, we constructed a yield curve model with the following two interest-rate generating process by maturity zone: (i) the short-term interest rate zone follows the traditional Vasicek model augmented by incorporating the probability of policy duration as one of the risk factors, and (ii) the long-term interest rate zone is determined by risk prices perceived in markets. By taking these steps, we significantly improved the fitting of the yield curve model under the ZIRP.

Suggested Citation

  • Kohei Marumo & Takashi Nakayama & Shinichi Nishioka & Toshihiro Yoshida, 2003. "Extracting Market Expectations on the Duration of the Zero Interest Rate Policy from Japan's Bond Prices," Bank of Japan Working Paper Series Financial Markets Departm, Bank of Japan.
    • Handle: RePEc:boj:bojwps:03-e-2f
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    References listed on IDEAS

    as
    1. Vasicek, Oldrich, 1977. "An equilibrium characterization of the term structure," Journal of Financial Economics, Elsevier, vol. 5(2), pages 177-188, November.
    2. David Heath & Robert Jarrow & Andrew Morton, 2008. "Bond Pricing And The Term Structure Of Interest Rates: A New Methodology For Contingent Claims Valuation," World Scientific Book Chapters, in: Financial Derivatives Pricing Selected Works of Robert Jarrow, chapter 13, pages 277-305, World Scientific Publishing Co. Pte. Ltd..
    3. Vasicek, Oldrich Alfonso, 1977. "Abstract: An Equilibrium Characterization of the Term Structure," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 12(4), pages 627-627, November.
    4. Vasicek, Oldrich A & Fong, H Gifford, 1982. "Term Structure Modeling Using Exponential Splines," Journal of Finance, American Finance Association, vol. 37(2), pages 339-348, May.
    5. Fujiki, Hiroshi & Shiratsuka, Shigenori, 2002. "Policy Duration Effect under the Zero Interest Rate Policy in 1999-2000: Evidence from Japan's Money Market Data," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 20(1), pages 1-31, January.
    6. Hull, John & White, Alan, 1990. "Pricing Interest-Rate-Derivative Securities," The Review of Financial Studies, Society for Financial Studies, vol. 3(4), pages 573-592.
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    Cited by:

    1. Hidenori Futami, 2009. "Multi-factor Affine Term Structure Model with Single Regime Shift: Real Term Structure under Zero Interest Rate," Asia-Pacific Financial Markets, Springer;Japanese Association of Financial Economics and Engineering, vol. 16(4), pages 347-369, December.
    2. Ben S. Bernanke & Vincent R. Reinhart & Brian P. Sack, 2004. "Monetary Policy Alternatives at the Zero Bound: An Empirical Assessment," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 35(2), pages 1-100.
    3. Kentaro Kikuchi, "undated". "A Term Structure Interest Rate Model with the Exit Time from the Negative Interest Rate Policy," Discussion Papers CRR Discussion Paper Series B: Financial 19, Shiga University, Faculty of Economics,Center for Risk Research.
    4. Hidenori Futami, 2011. "Regime Switching Term Structure Model Under Partial Information," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 14(02), pages 265-294.
    5. Hiroshi Ugai, 2007. "Effects of the Quantitative Easing Policy: A Survey of Empirical Analyses," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 25(1), pages 1-48, March.
    6. DECAMPS, Marc & DE SCHEPPER, Ann & GOOVAERTS, Marc, "undated". "Path integrals as a tool for pricing interest rate contingent claims: The case of reflecting and absorbing boundaries," Working Papers 2003027, University of Antwerp, Faculty of Business and Economics.
    7. Hiroshi Ugai, 2006. "Effects of the Quantitative Easing Policy: A Survey of Empirical Analyses," Bank of Japan Working Paper Series 06-E-10, Bank of Japan.

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