| 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. |