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The Japanese Repo Market: Theory and Evidence

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  • Baba, Naohiko

    (Bank of Japan)

  • Inamura, Yasunari

    (Bank of Japan)

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    Abstract

    Repurchase agreement (repo) transactions are widely used as a risk-free means of borrowing or lending funds and securities. Repo transactions can be categorized into (1) general collateral (GC) repos that borrow or lend funds, and (2) special collateral (SC) repos that borrow or lend specific securities. GC repo rates are priced at a level close to the risk-free interest rate, while SC repo rates are often priced far below the GC repo rates. This paper aims to examine the pricing mechanism of the Japanese repo market from both theoretical and empirical perspectives. First, Duffie (1996) and Krishnamurthy (2001) show that (1) equilibrium in the repo market requires no-arbitrage profits from combining repo and cash bond transactions, (2) the equilibrium level of repo spreads between GC and SC repo rates is determined at the point where the supply and demand curves of the underlying bond issues intersect in the repo market, and (3) expected returns from future matched book trading are reflected in the cash prices of SC bond issues. Second, the paper empirically examines the above theoretical implications using the data of repo rates and government bond prices in Japan. Our empirical results show that, regarding the on-the- run and the cheapest-to-deliver (CTD) issues, the above no-arbitrage condition is significantly satisfied.

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    File URL: http://www.imes.boj.or.jp/research/papers/english/me22-1-3.pdf
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    Bibliographic Info

    Article provided by Institute for Monetary and Economic Studies, Bank of Japan in its journal Monetary and Economic Studies.

    Volume (Year): 22 (2004)
    Issue (Month): 1 (March)
    Pages: 65-90

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    Handle: RePEc:ime:imemes:v:22:y:2004:i:1:p:65-90

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    1. McCulloch, J Huston, 1975. "The Tax-Adjusted Yield Curve," Journal of Finance, American Finance Association, vol. 30(3), pages 811-30, June.
    2. Jordan, Bradford D & Jordan, Susan D, 1997. " Special Repo Rates: An Empirical Analysis," Journal of Finance, American Finance Association, vol. 52(5), pages 2051-72, December.
    3. Buraschi, Andrea & Menini, Davide, 2002. "Liquidity risk and specialness," Journal of Financial Economics, Elsevier, vol. 64(2), pages 243-284, May.
    4. Frank Keane, 1996. "Repo rate patterns for new Treasury notes," Current Issues in Economics and Finance, Federal Reserve Bank of New York, vol. 2(Sep).
    5. Mark D. Griffiths & Drew B. Winters, 1997. "The Effect of Federal Reserve Accounting Rules on the Equilibrium Level of Overnight Repo Rates," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 24(6), pages 815-832.
    6. Duffie, Darrell, 1996. " Special Repo Rates," Journal of Finance, American Finance Association, vol. 51(2), pages 493-526, June.
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