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

Koichiro Kamada and Ko Miura
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Ko Miura: Bank of Japan

No 14-E-6, Bank of Japan Working Paper Series from 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.

Date: 2014-04-11
New Economics Papers: this item is included in nep-fmk and nep-mon
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Citations: View citations in EconPapers (12)

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