Interesting paper released by R. Wepachowski from Markit, well-known for their credit risk indices.

Abstract:The Libor Market Model describes the evolution of a discrete subset of all interest rates quoted in the market. Generation of the complete yield curve from a simulated set of rates (the so-called “Libor rate interpolation”) is one of the basic challenges which are faced by a practical user of LMM. Incorrect implementation can lead to arbitrage in the model and render generated prices invalid. In this paper, we present a rate interpolation scheme which not only is arbitrage-free, but also generates a natural-looking, smooth term structure of interpolated rates’ volatilities. It is conceptually simple and computationally efficient.

R. Werpachowski. Arbitrage-Free Rate Interpolation Scheme for Libor Market Model with Smooth Volatility Term Structure.

Here’s a new paper from the Fed that tries to determine the actual effect of asset purchases on the yield curve.  Abstract below!

Abstract: Using a panel of daily CUSIP-level data, we study the effects of the Federal Reserve’s program to purchase $300 billion of U.S. Treasury coupon securities announced and implemented during 2009. This program represented an unprecedented intervention in the Treasury market and thus allows us to shed light on the price elasticities and substitutability of Treasuries, preferred-habitat theories of the term structure, and the ability of large-scale asset purchases to reduce overall yields and improve market functioning. We find that each purchase operation, on average, caused a decline in yields in the sector purchased of 3.5 basis points on the days when these purchases occurred (the “flow effect” of the program). In addition, the program as a whole resulted in a persistent downward shift in the yield curve of as much as 50 basis points (the “stock effect”), with the largest impact in the 10- to 15-year sector. The coefficient patterns generally support a view of segmentation or imperfect substitution within the Treasury market.

S. D’Amico. T. B. King. Flow and Stock Effects of Large-Scale Treasury Purchases. FEDS Working Paper No. 2010-52.

I’m going to assume that you’ve heard that the number is $600B in expansion, putting the total amount of purchases including reinvestment at just shy of $1T. Here are some excerpts from the official statement that are more interesting, as well as my emphasis added in bold:

Purchases associated with balance sheet expansion and those associated with principal reinvestments will be consolidated into one set of operations to be announced under the current monthly cycle. On or around the eighth business day of each month, the Desk will publish a tentative schedule of purchase operations expected to take place through the middle of the following month, as well as the anticipated total amount of purchases to be conducted over that period. The schedule will include a list of operation dates, settlement dates, security types to be purchased (nominal coupons or TIPS), the maturity date range of eligible issues, and an expected range for the size of each operation.

The Desk expects to conduct the November 4 and November 8 purchase operations that were announced on October 13, and it plans to publish its first consolidated monthly schedule on November 10 at 2:00 p.m.

Purchases will be conducted with the Federal Reserve’s primary dealers through a series of competitive auctions operated through the Desk’s FedTrade system. Consistent with current practices, the results of each operation will be published on the Federal Reserve Bank of New York’s website shortly after each purchase operation has concluded. In order to ensure the transparency of our purchase operations, the Desk will also begin to publish information on the prices paid in individual operations at the end of each monthly calendar period, coinciding with the release of the next period’s schedule.

Note that this means that much more out-of-sample prediction may be possible in the future for POMO, both due to better prospective data release and higher detail in released training data.

Here’s a nasty looking headline from FT’s 6am cut this morning (which is now paywalled, btw)  - European bank bail-ins will cost +87 basis points.  The article summarizes the results of a JP Morgan survey on the effect of various “bail-in” options.  Here’s JPM’s summary:

Survey responses indicated that the implementation of bail-in frameworks is likely to have a material impact on the pricing of senior debt. Firstly, respondents indicated that the greater loss outcomes associated with bail-in regimes are not being priced in, despite the existence of special resolution regimes which already may imply similar loss outcomes for senior bondholders. Secondly, the average risk premium that investors would demand for a single ‘A’ bank under a bail-in regime would be 87bp. Thirdly, investors clearly expect that the implementation of a bail-in framework will lead to an increase in price differentials across issuers of differing credit quality. In our opinion, the sum total of the implementation bail-in regimes together with the current extensive regulatory capital reform process could be a major driver of M&A activity amongst the European banking sector, as smaller and lower ratings issuers may struggle to access capital markets at levels which allows their business models to remain intact.


Around a year ago, Dan and I put up an animation of the major foreign holders of Treasury securities from 2002 to 2009 at my other blog, Computational Legal Studies.  At the time, the conversation was driven by China surpassing Japan as the largest foreign holder.

Since then, there’s been quite a bit of speculation as to when the Federal Reserve would surpass these largest foreign holders.  The Fed has been acquiring these securities through its various Open Market Operations (OMO).  However, I think focusing on just this Fed-vs.-China benchmark may be a bit misleading.

The animation below shows the proportion of Treasury securities held by the Federal Reserve, Japan, China, and all other foreign holders of Treasury securities between 2004 and 2010.  The Federal Reserve holdings are based on the second column of the Fed’s latest H.4.1 and are current up to October 21st.  The Treasury’s TIC data (historical here) is significantly lagged, however, and only current as of the end of August.  Therefore, I’ve held the values constant from August for foreign holders, though the Fed’s slice does change based on real data.

I’ll let the video mostly speak for itself, but note that the increase in the Fed’s holdings are relatively dwarfed by the increase in total foreign holdings.

N.B.: It’s HD, make sure the watch the video in fullscreen!

Holders of Treasury Securities, 2004-2010 from Computational Legal Studies on Vimeo.