Fixed Income Market Research Articles

Assessment of Dealer Capacity to Intermediate in Treasury and Agency MBS Markets

We provide an assessment of broker-dealers’ current and future capacity to support the smooth functioning of the Treasury and agency MBS markets, considering increases in Treasury issuance and continued Federal Reserve balance sheet normalization. Drawing on regulatory data analysis, recent research, and experiences with fixed income market functioning, we focus on two types of constraints that are most relevant for dealers’ intermediation activities: regulatory constraints—specifically the minimum Supplementary Leverage Ratio (SLR) requirement at the Bank Holding Company (BHC) level—and internal risk limits—specifically Value at Risk (VaR) limits at the trading-desk level for each dealer.

Financial liberalization or state capitalism? The developmental state and the special purpose bond market in South Korea

ABSTRACT South Korea's state-guaranteed bond market was nearly half the size of its sovereign bond market in 2022, and in the early 2000s, it was nearly twice the size of the latter. What explains the overwhelming prominence of this fixed-income market? This paper finds that the prominence of this market is a path-dependent consequence of developmental legacies and the Asian Financial Crisis. State-guaranteed bonds allowed the state to circumvent conditionalities that limited the state's ability to access domestic savings for policy objectives and helped shield the newly established sovereign bond market from premature supply pressure. This finding demonstrates that the state not only supports or creates markets but also uses markets to maintain its influence against external pressure. It also explains how the South Korean state was able to maintain its developmental policies after market liberalisation by tracking the post-crisis flow of domestic savings.

Unclaimed Dividends and Performance of the Fixed Income Market in Nigeria

This study investigated the effects of unclaimed dividends on the performance of the fixed income market in Nigeria from 1991 to 2021, with the specific objectives of determining the extent to which unclaimed dividends of less than 15 months, unclaimed dividends with registrars and unclaimed dividends with companies have affected market capitalization of the fixed income market in Nigeria. The study utilized 31 years annual time series data obtained from CBN and SEC statistical bulletins for 2021. Johansen co-integration, ECM estimation and granger causality techniques were used to ascertain the short and long run relationship among these variables. Results indicated that a long run relationship exist between unclaimed dividends and performance of the fixed income market, while the speed of adjustment in event of any distortion is about 62.5%. It was also revealed that only unclaimed dividends with companies have a positive effect on market capitalization of the fixed income market; while unclaimed dividends of less than 15 months, unclaimed dividends with registrars and unclaimed dividends with Companies have a joint significant effect of about 80% on market capitalization of the fixed income market. It was as such deduced that unclaimed dividends has a long run significant effect on the performance of the fixed income market in Nigeria. The study therefore suggested that there is need for sincerity on the part of the government, SEC and registered companies to reduce the volume of unclaimed dividends in Nigeria; as this will go a long way in boosting the performance of the Nigerian capital market.

Active versus Passive: In the Bond Universe

The recent rapid growth of passive investment instruments in the fixed-income market raises the question of their relative outperformance compared to corresponding active investment strategies. This article analyzes an ample sample of actively managed global bond funds over the period from 2010 to 2020 and compares them with the performance of the passive instruments tracking the apposite bond market index, namely, the Bloomberg Barclays Multiverse Index. On average, the active bond managers and index are roughly in line. However, a closer look at the distribution of returns on active strategies shows that some managers are successful in beating the index frequently or over many years.

BONDS AND SUKUK MARKETS UNDER COVID 19: AN EMPIRICAL STUDY OF EMERGING MARKETS

The influence of the COVID-19 pandemic on the bonds and sukuk market index is investigated to determine the dynamic behavior of fixed-income return volatility. Our results suggest that COVID-19 does not influence bond and sukuk market volatility in most of our samples. Furthermore, market sentiment does not exist in the fixed income market. The dominance of long-term investors in the fixed-income market could be the cause, especially given the minor impact of the pandemic on market volatility. In erms of risk, sukuk is less risky than its counterpart, and no statistical difference is found in risk before and during the COVID-19 pandemic for sukuk and bonds. Finally, sukuk may be considered a safe haven instrument in the financial market coupled with bonds as diversification tools in the investors’ portfolios

Things Fall Apart: Fixed Income Markets in the COVID-19 Crisis

This article provides a critical appraisal of the March 2020 crisis in fixed income markets. We synthesize the main events, characterize what appears to be an emerging consensus on what caused the market breakdowns, summarize how the Federal Reserve's actions contributed to its resolution, and discuss potential lasting effects of the crisis. This review makes clearer the fragilities and interconnectedness that characterize the current fixed income market structure and their effects on liquidity provision. We argue that the current market structure, combined with the continued growth of Treasury markets, corporate and municipal bond markets, and particularly, mutual funds, raises the specter that periodic instability may remain a feature of fixed income markets.

Market participants or the random walk – who forecasts better? Evidence from micro-level survey data

We analyse micro-level data concerning four financial variables in Sveriges Riksbank's Prospera Survey to evaluate the precision of forecasts provided by professionals active in the Swedish fixed-income market. Our results indicate that for the SEK/EUR and SEK/USD exchange rates, and the five-year government bond yield, none of the market participants that frequently participate in the survey manage to significantly outperform the random-walk forecast. For the central bank's policy rate, the market participants typically have a statistically significant higher forecast precision than the random-walk forecast at the three-month horizon; however, at the two- and five-year horizons, the random-walk forecast typically outperforms the market participants.

Hedging demand and near-zero swap spreads: Evidence from the Chinese interest rate swap market

Interest rate swap plays an essential role in the Chinese fixed-income market as a mainly hedging instrument. However, the market pricing anomaly of the near-zero swap spread violates the non-arbitrage assumption. Investigating the dynamics of pricing factors on interest rate swaps is meaningful to explain near-zero swap spreads. This paper employs a vector autoregressive model with time-varying parameters (TVP-VAR) model to examine the dynamic effects of pricing factors on swap spreads from a business cycle perspective. An analysis of the main three swaps with 1-year, 2-year, and 5-years maturities indicates that the TVP-VAR model accurately describes the time-varying features of the economic determinants. The TVP-VAR model has higher forecasting accuracy than the TVP model, particularly in the first-three months after the start of Covid-19 pandemic. The level, interest rate volatility (or economic policy uncertainty index), and stock market volatility as the proxies for hedging demands show opposite effects to the theoretical predictions. These effects are evident before 2010 (international financial crisis), during a short period in 2015 (stock market crashes), and after 2019 (Covid-19 pandemic). Thus, we provide different explanations of the effects of the hedging demand on near-zero swap spreads.

The Long Term Comovement Between Sukuk And Conventional Fixed Income Markets

Sukuk markets have made significant progress both in terms of market volumes and international awareness in recent years. These financial products are specially designed for investors who avoid interest gain. On the other hand, it is an ongoing issue in the literature whether these markets are a useful alternative for conventional fixed income investors as well. Our main purpose is to explore sukuk market as an investment alternative for conventional fixed income market investors' points of view. Since the integration of assets is one of the key criteria for portfolio investments, this study investigated the long-term comovements between sukuk and other fixed-income indexes via Johansen and Engle-Granger cointegration technique. To proxy international fixed income portfolio, international bond indexes which are prepared by FTSE (Financial Times Stock Exchange Group) are employed. Besides, the vector error correction model is also applied to deepen the results. According to the findings, there is a limited causality in the long run between sukuk markets and conventional bond markets. This can make international sukuk assets highly beneficial diversification alternative to conventional bond portfolios. The study aims to contribute to the literature by examining the benefits of sukuk markets as an investment alternative to conventional, wide-range fixed income markets.

Demystifying the US Treasury floating rate note puzzle: A swap market perspective

We compare two versions of the US Treasury floating rate note (FRN) price measured in Treasury auctions and in the swap market. Utilizing a proprietary dataset from J.P. Morgan, we find that the actual US Treasury FRNs are traded in premium in comparison with their synthetic equivalents in the swap market, and the premium amounts to four basis points on average. Moreover, they are priced up by four more basis points when the aggregate fixed income market is in turmoil, confirming that US Treasury FRNs are indeed safe assets, and thus require a price premium ex ante.

Machine Learning–Based Systematic Investing in Agency Mortgage-Backed Securities

With a total outstanding balance of more than $8 trillion as of this writing, agency mortgage-backed securities (MBS) represent the second largest segment of the US bond market and the second most liquid fixed-income market after US Treasuries. Institutional investors have long participated in this market to take advantage of its attractive spread over US Treasuries, low credit risk, low transaction cost, and the ability to transact large quantities with ease. MBS are made of individual mortgages extended to US homeowners. The ability for a homeowner to refinance at any point introduces complexity in prepayment analysis and investing in the MBS sector. Traditional prepayment modeling has been able to capture many of the relationships between prepayments and related factors such as the level of interest rates and the value of the embedded prepayment option, yet the manual nature of variable construction and sheer amount of available data make it difficult to capture the dynamics of extremely complex systems. The long history and large amount of data available in MBS make it a prime candidate to leverage machine learning (ML) algorithms to better explain complex relationships between various macro- and microeconomic factors and MBS prepayments. The authors propose a systematic investment strategy using an ML-based mortgage prepayment model approach combined with a coupon allocation optimization model to create an optimal portfolio to capture alpha vs. a benchmark.

Event studies in international finance research.

Event studies are widely used in finance research to investigate the implications of announcements of corporate initiatives, regulatory changes, or macroeconomic shocks on stock prices. These studies are often used in a single-country setting (usually the U.S.), but little work has yet been conducted in an international context, perhaps due to the complexities inherent in implementing cross-country studies. This paper explores the methodological challenges of conducting event studies in international finance research. We emphasize how scholars should choose an event, select the study period (short vs. long term), estimate abnormal returns, infer statistically whether the event under consideration produces a reliable price reaction, and explore the role of formal and informal institutions in explaining cross-country differences in price reactions. We also provide an extension of event studies to an important but less studied asset class in an international setting – the fixed-income market. We conclude by offering practical recommendations for researchers conducting cross-country finance event studies and identifying opportunities for future research. Given the increasing number of global events, such as the COVID-19 pandemic, Brexit, and the Paris and Trans-Pacific Partnership agreements, we believe our paper is especially timely.

Spillover dynamics effects between risk-neutral equity and Treasury volatilities

Macro-finance asset pricing models provide a rationale for connectedness dynamics between equity and Treasury risk-neutral volatilities. In this paper, we study the total and directional connectedness, in the sense of spillover effects, between risk-neutral volatilities from the equity and Treasury markets. In addition, we analyze the economic and monetary drivers of connectedness dynamics. Most of the time, but especially during bad economic times, we find significant net spillovers from Treasury to equity risk-neutral volatility. The spillover channel between risk-neutral volatilities arises mainly through the government fixed income market.

Allocating to Green Bonds

Green bonds are about a decade old financial instrument with cash flows earmarked to improve the environment or combat climate change. The author shows the spectacular growth of the asset class over time but notes that it is currently still less than 1% of the investment grade fixed income market. The composition of the asset class has changed considerably over time. At the start, it was mainly very safe supranational institutions issuing in various currencies with relatively short maturities. Corporates, especially utilities, followed them, and more recently, governments have started issuing green bonds. These sharp composition changes make historical data from before 2015 less representative for the future. The author’s returns- and characteristics-based analyses show that investors allocating to green bonds should finance this from an aggregate fixed income allocation if they want to reduce the impact on the risk and return characteristics of the existing portfolio.

The Impact of Covid-19 on the Business of Insurers and Reinsurers

Abstract According to the impact, infectious diseases are a critical risk for 2020 and the following years in the Global Risk Report. The realization of the Covid-19 virus set the pandemic as a crucial global risk for humans, the economy, and society. The main idea of this paper is to give insight into the global socio-economic consequences of the actual Covid-19 pandemic, with a specific view of the business of insurance and reinsurance companies, who are responding to the widening of the COVID-19 pandemic on multiple fronts—as claims payers, employers, and investment managers. Considering that both individuals and businesses face high costs and losses regarding disruption of travel, business interruption, and supply chains, many expect insurers to reimburse some of these costs and losses. Insurance companies are also significant investors in financial markets and will face losses due to equity and fixed income market losses regarding decreasing interest rates as an attempt of central banks worldwide to support their economies. The current crisis can also be considered the possibility of improving the insurance coverage related to pandemics by establishing (re)insurance schemes and pooling arrangements for other catastrophic risks and developing public-private partnerships to support the insurability of pandemic risk.

Bonds duration and COVID-19: A study on United Kingdom conventional gilts

This article studies whether the government bonds portfolio developed based on bonds duration produces abnormal returns in London Stock Exchange fixed income market during the phase of double-dip recession and COVID-19. The sample consists of UK conventional gilts traded from February 2004 till February 2021. The daily data is obtained from Thomson Reuters / Refinitiv Eikon. For this study, the data is divided into two subsamples July 2009-December 2018 and December 2019-February 2021. The findings reveal that all the bonds produced abnormal returns during the complete sample and sub-sample period when returns of UK gilts 1 year maturity are kept as a proxy for risk-free and 50-year maturity bond as a proxy for the market return. However, R2 shows weak model of portfolios with durations 2 and 3, which indicates that bondholders do not prefer to invest in gilts with these durations during the growth phase. The second sub-period results show weak portfolio returns with 3, 4, 8, and 20 years of durations during the pandemic. This indicates that bondholders tend to be conservative for short-term gilts due to low and negative yields.

Predicting risk-adjusted returns using an asset independent regime-switching model

Financial markets tend to switch between various market regimes over time, making stationarity-based models unsustainable. We construct a regime-switching model independent of asset classes for risk-adjusted return predictions based on hidden Markov models. This framework can distinguish between market regimes in a wide range of financial markets such as the commodity, currency, stock, and fixed income market. The proposed method employs sticky features that directly affect the regime stickiness and thereby changing turnover levels. An investigation of our metric for risk-adjusted return predictions is conducted by analyzing daily financial market changes for almost twenty years. Empirical demonstrations of out-of-sample observations obtain an accurate detection of bull, bear, and high volatility periods, improving risk-adjusted returns while keeping a preferable turnover level.

Risk-free interest rates

We estimate risk-free interest rates unaffected by convenience yields on safe assets. We infer them from risky asset prices without relying on any specific model of risk. We obtain interest rates and implied convenience yields with maturities up to three years at a minutely frequency. Our estimated convenience yield on Treasuries equals about 40 basis points, is larger below three months maturity, and quadruples during the financial crisis. In high-frequency event studies, conventional and unconventional monetary stimulus reduces our rates more than the corresponding Treasury yields, thus broadly affecting rates even outside the narrow confines of the fixed-income market.

Information content and market liquidity in the fixed income market: Evidence from the swaption market

In this paper, I investigate the relationship between market liquidity and the information content of implied volatility (IV) in the fixed income market. For its part, financial regulation including Basel III relies heavily on historical volatility (HV) in capturing the financial risk of financial institutions. One of the main reasons for this is that many countries may not necessarily obtain a meaningful measure of IV in their option markets because of the lack of liquidity. Using US dollar and Japanese yen swaption data, I find that the information content of IV critically depends on the measure of liquidity. This finding empirically justifies the use of HV instead of IV as a financial risk measure, especially in countries where option market liquidity is low.

COVID‐19 and ESG preferences: Corporate bonds versus equities

I examine investors' within ESG investment preferences during the COVID‐19 pandemic by investigating the return spillover effects across the three different corporate bonds and equities‐based investment strategies. Investors prefer making investments in ESG leaders in the investment‐grade corporate bond market over ESG leaders in the equity and high yield corporate bond markets during times of uncertainty. It suggests that capital flows away from high yield corporate bond and equity markets to the investment‐grade corporate bond market. Investors find refuge in firms with relatively higher ESG ratings and creditworthiness in the fixed income market over the equity market during crisis periods.