The Anatomy of the Ten-Year Floating-Rate Retail JGB-An Approach Based on the FRA Market Model-

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  • Anatomy of the Ten Year Floating Rate Retail JGB An Approach Based on the FRA Market Model

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The Ministry of the Treasury began to issue ten-year floating rate JGBs for retail purposes in March2003, as part of the establishment of a funding diversification policy. Many security firmsadvertised these securities by means of recommendation letters that detailed the attractivecharacteristics of these products. However, to my knowledge, no research has yet evaluated thevalue of these products by means of an appropriate valuation model. The aim of this paper was toquantitatively clarify the attractive qualities of the ten-year floating-rate retail JGB, by means of acomparison with the 15-year floating-rate wholesale JGB, and with other imaginary products. Inthe course of this study, I make use of the following powerful valuation tools: (1) a convexitycorrection through a numeraire change (Jamshidian, F.), (2) long-jump and very-long-jumpapproaches (Rebonato, R.), and (3) Kloeden and Platen’s Runge-Kutta-like weak approximation.My major empirical findings are comprised of the following three results. First, the value of the tenyearfloating-rate retail JGB is generally larger than that of the 15-year floating-rate wholesale JGB.Second, the price sensitivity of the former, with respect to the α BP that is subtracted from thebase rate, is not monotonically decreasing. Third, the impetus of the second result is the trade-off,resulting from an increase in α BP, between the decrease in the projected future cash flow and theincrease in the intrinsic value of the embedded American put option.

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