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Confidence Erosion and Herding Behavior in Bond Markets: An Essay on Central Bank Communication Strategy

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  • Koichiro Kamada

    (Bank of Japan)

  • Ko Miura

    (Bank of Japan)

Abstract

This paper examines the distinctive behavior of long-term interest rates observed after the Bank of Japan's introduction of quantitative and qualitative monetary easing, by focusing on changes in traders' confidence and herding behavior. When participants in bond markets lose confidence in their outlook for future interest rates, their investment decision depends heavily on the developments of market prices. This often leads to herding behavior among traders and destabilizes market prices: demand fuels further demand, or supply fuels further supply. This study develops a theoretical model and employs it for stochastic simulations to show that volatility of bond prices and trading volumes is affected by a number of factors, such as investors' confidence in the financial environment, the usefulness or value of information available in the market, and the market liquidity of bonds. In addition, the model is fitted to actual data to specify the driving forces underlying the changes in long-term interest rate volatility observed in 2013. The analysis shows that the key to understanding the developments in long-term interest rates during this period lies in how traders interpreted information flows in the market, especially the announcement by the Bank of Japan regarding its policy change, and in capturing the extent to which their confidence was weakened or strengthened by those information flows. The findings of the analysis highlight the importance of formulating a communication strategy as part of the conduct of monetary policy and the challenges in implementing such a strategy.

Suggested Citation

  • Koichiro Kamada & Ko Miura, 2014. "Confidence Erosion and Herding Behavior in Bond Markets: An Essay on Central Bank Communication Strategy," Bank of Japan Working Paper Series 14-E-6, Bank of Japan.
    • Handle: RePEc:boj:bojwps:wp14e06
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    References listed on IDEAS

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    1. Xavier Gabaix & Parameswaran Gopikrishnan & Vasiliki Plerou & H. Eugene Stanley, 2006. "Institutional Investors and Stock Market Volatility," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 121(2), pages 461-504.
    2. Makoto Nirei & Tsutomu Watanabe, 2014. "Beauty Contests and Fat Tails in Financial Markets," CARF F-Series CARF-F-346, Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo.
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    Cited by:

    1. Donato Masciandaro & Davide Romelli & Gaia Rubera, 2021. "Monetary policy, Twitter and financial markets: evidence from social media traffic," BAFFI CAREFIN Working Papers 21160, BAFFI CAREFIN, Centre for Applied Research on International Markets Banking Finance and Regulation, Universita' Bocconi, Milano, Italy.
    2. Kamada, Koichiro & Kurosaki, Tetsuo & Miura, Ko & Yamada, Tetsuya, 2022. "Central bank policy announcements and changes in trading behavior: Evidence from bond futures high frequency price data," The North American Journal of Economics and Finance, Elsevier, vol. 59(C).
    3. Makoto Nirei & John Stachurski & Tsutomu Watanabe, 2018. "Trade Clustering and Power Laws in Financial Markets (Published in Theoretical Economics, 15:1365?1398, 2020)," CARF F-Series CARF-F-450, Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo.
    4. Makoto Nirei & Tsutomu Watanabe, 2014. "Beauty Contests and Fat Tails in Financial Markets," UTokyo Price Project Working Paper Series 024, University of Tokyo, Graduate School of Economics.
    5. Nirei, Makoto & Stachurski, John & Watanabe, Tsutomu, 2020. "Trade clustering and power laws in financial markets," Theoretical Economics, Econometric Society, vol. 15(4), November.
    6. Donato Masciandaro & Davide Romelli & Gaia Rubera, 2020. "Tweeting on Monetary Policy and Market Sentiments: The Central Bank Surprise Index," BAFFI CAREFIN Working Papers 20134, BAFFI CAREFIN, Centre for Applied Research on International Markets Banking Finance and Regulation, Universita' Bocconi, Milano, Italy.
    7. Michael Chui & Ingo Fender & Vladyslav Sushko, 2014. "Risks related to EME corporate balance sheets: the role of leverage and currency mismatch," BIS Quarterly Review, Bank for International Settlements, September.
    8. Donato Masciandaro & Davide Romelli & Gaia Rubera, 2021. "Monetary policy and financial markets: evidence from Twitter traffic," BAFFI CAREFIN Working Papers 21160, BAFFI CAREFIN, Centre for Applied Research on International Markets Banking Finance and Regulation, Universita' Bocconi, Milano, Italy.
    9. Donato Masciandaro & Davide Romelli, 2016. "From Silence to Voice: Monetary Policy, Central Bank Governance and Communication," BAFFI CAREFIN Working Papers 1627, BAFFI CAREFIN, Centre for Applied Research on International Markets Banking Finance and Regulation, Universita' Bocconi, Milano, Italy.

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