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Inflation Expectations, Liquidity Premia and Global Spillovers in Japanese Bond Markets

Author

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  • Jens H. E. Christensen
  • Mark M. Spiegel

Abstract

We provide market-based estimates of Japanese inflation expectations using an arbitrage-free dynamic term structure model of nominal and real yields that accounts for liquidity premia and the deflation protection afforded by Japanese inflation-indexed bonds, known as JGBi’s. We find that JGBi liquidity premia exhibit significant variation, and even switch sign. Properly accounting for them significantly lowers the estimated value of the indexed bonds’ deflation protection and affects inflation risk premium estimates. After liquidity adjustment, long-term Japanese inflation expectations have remained relatively stable at levels modestly exceeding one percent during the pandemic period. We then utilize our estimated liquidity measure to confirm the existence of statistically significant and economically meaningful spillovers to the JGBi market from global bond market illiquidity, as proxied by periods of low U.S. Treasury market depth.

Suggested Citation

  • Jens H. E. Christensen & Mark M. Spiegel, 2024. "Inflation Expectations, Liquidity Premia and Global Spillovers in Japanese Bond Markets," Working Paper Series 2024-12, Federal Reserve Bank of San Francisco.
    • Handle: RePEc:fip:fedfwp:98059
    DOI: 10.24148/wp2024-11
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    More about this item

    Keywords

    affine arbitrage-free term structure model; deflation risk; deflation protection; Liquidity Spillovers;
    All these keywords.

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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