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

2. EFFAS-EBC meeting, June 20092 Contents: 1 Chinese Bonds Market Overview 3 Applying EFFAS-EBC methodology to Chinese Bonds Market 2 Zero-coupon yield curve used by CGSDTC

3. EFFAS-EBC meeting, June 20093 Market scale About 3000 bonds with total worth 34 704,6 billion RMB issued since 1998 Currently traded: 1385 bonds with outstanding amount 16 600 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

4. EFFAS-EBC meeting, June 20094 Chinese Bonds Market Structure Source: ChinaBond

5. EFFAS-EBC meeting, June 20095 Chinese Bonds Market Structure Source: ChinaBond

6. EFFAS-EBC meeting, June 20096 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.

7. EFFAS-EBC meeting, June 20097 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

8. EFFAS-EBC meeting, June 20098 Outstanding Amount

9. EFFAS-EBC meeting, June 20099 Current position: 1 Chinese Bonds Market Overview 3 Applying EFFAS-EBC methodology to Chinese Bonds Market 2 Zero-coupon yield curve used by CGSDTC

10. EFFAS-EBC meeting, June 200910 History of Zero-Coupon Yield Curves Development in China Research (1999-2001). With aid of Reuters was developed first yield curve for Treasure bonds Prototypes (2002-2005). Chinese development of 4 yield curves for Treasure bonds using information from different markets Exploitation and Modification (2006 - Present). New methods are developed and yield curves are constructed for different types of bonds.

11. EFFAS-EBC meeting, June 200911 CGSDTC Methodology Data Filtering Expert and Historical Estimates Hermite Polynomial Fitting

12. EFFAS-EBC meeting, June 200912 Data Sources Deals Prices from Interbank, OTC and Shanghai Exchange markets Bid-Ask Quotes from Interbank market Market Participants estimates

13. EFFAS-EBC meeting, June 200913 Data Filtering Visual comparison with historical yield curves, not historical market data

14. EFFAS-EBC meeting, June 200914 Expert and Historical Estimates If too many entries are filtered out the data is augmented with expert estimates or historical values

15. EFFAS-EBC meeting, June 200915 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

16. EFFAS-EBC meeting, June 200916 Controversial results

17. EFFAS-EBC meeting, June 200917 Current position: 1 Chinese Bonds Market Overview 3 Applying EFFAS-EBC methodology to Chinese Bonds Market 2 Zero-coupon yield curve used by CGSDTC

18. EFFAS-EBC meeting, June 200918 Available data Chinabond has kindly supplied us with the following data: –Daily trading results. –Daily OTC Bid/Ask quotes from 8 banks.

19. EFFAS-EBC meeting, June 200919 Quotes co-Movement

20. EFFAS-EBC meeting, June 200920 Bid-Ask Spread co-Movement

21. EFFAS-EBC meeting, June 200921 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.

22. EFFAS-EBC meeting, June 200922 “Best” inter-bank Bid-Ask spreads

23. EFFAS-EBC meeting, June 200923 Quotes: Yield Curves

24. EFFAS-EBC meeting, June 200924 Quotes: Forward Rates

25. EFFAS-EBC meeting, June 200925 Quotes: (Bid+Ask)/2

26. EFFAS-EBC meeting, June 200926 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)

27. EFFAS-EBC meeting, June 200927 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

28. EFFAS-EBC meeting, June 200928 Number of Deals

29. EFFAS-EBC meeting, June 200929 Turnover

30. EFFAS-EBC meeting, June 200930 Price vs. Bid-Ask

31. EFFAS-EBC meeting, June 200931 Prices: Yield curves

32. EFFAS-EBC meeting, June 200932 More smoothing

33. EFFAS-EBC meeting, June 200933 High-Coupon Effect? Hypothesis: Chinese traders like high coupons (bonds with high coupons are valued higher). Testing: corr(coupon size, spread) = 10%

34. EFFAS-EBC meeting, June 200934 Visual Coupons

35. EFFAS-EBC meeting, June 200935 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