Liquidity-Adjusted Benchmark Yield Curves: A Look at Trading Concentration and Information

William T. Lin and David Sun
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William T. Lin: Department of Banking and Finance, Tamkang University, Tamsui, Tapiei, Taiwan 25137, Taiwan

Review of Pacific Basin Financial Markets and Policies (RPBFMP), 2007, vol. 10, issue 04, 491-518

Abstract: Estimation of benchmark yield curve in developing markets is often influenced by liquidity concentration. Based on an affine term structure model, we develop a long run liquidity weighted fitting method to address the trading concentration phenomenon arising from horizon-induced clientele equilibrium as well as information discovery. Specifically, we employ arguments from models of liquidity concentration and benchmark security information. After examining time series behavior of price errors against our fitted model, we find results consistent with both the horizon and information hypotheses. Our evidence indicates that trading liquidity carries information effect in the long run, which cannot be fully captured in the short run. Trading liquidity plays a key role in long run term structure fitting. Markets for liquid benchmark government bond issues collectively form a long term equilibrium. Compared with previous studies, our results provide a robust and realistic characterization of the spot rate term structure and related price forecasting over time, which in turn help portfolio investment of fixed income and long run pricing of financial instruments.

Keywords: Liquidity; trading concentration; information discovery; term structure; yield curve; JEL Classification: D4; JEL Classification: D53; JEL Classification: D83; JEL Classification: E43; JEL Classification: G12 (search for similar items in EconPapers)
JEL-codes: G1 G2 G3 (search for similar items in EconPapers)
Date: 2007
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Citations: View citations in EconPapers (3)

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Working Paper: Liquidity-adjusted benchmark yield curves: a look at trading concentration and information (2007)
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DOI: 10.1142/S0219091507001173

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