Scarcity and Spotlight Effects on Liquidity and Yield: Quantitative Easing in Japan

We investigate the determinants of the term structures of market liquidity and bond yield of the Japanese Government Bond (JGB) market in the context of the quantitative easing (QE) programs implemented by the Bank of Japan (BoJ) in recent years. We distinguish between two opposing effects of QE on the liquidity of JGBs, the “scarcity effect,” which is gradually manifested as a negative impact on liquidity, due to the shrinkage in the available supply of bonds; and the “spotlight effect,” which induces an immediate improvement in the liquidity of targeted bonds, reflecting BOJ’s massive demand. Between 2011 and 2016, we find that JGBs exhibited an improvement in liquidity through the spotlight effect, but also experienced a deterioration in liquidity through the scarcity effect. As for bond yields, both the spotlight and scarcity effects worked in the same direction (i.e., they both raised (reduced) bond prices (yields), as expected). However, despite the illiquidity caused by the scarcity induced by the purchases, this yield decline is amplified rather than being muted, despite the elevated illiquidity premium.


Presented at:

• Nihon Finance Association Annual Conference in Tokyo (Jun 2017)

• IFABS Asia in Ningbo (Sep 2017)

• EUROFIDAI European Financial Data Institute - 15th Paris December Finance Meeting in Paris (Dec 2017)

• 30th Australasian Finance and Banking Conference in Sydney (Dec 2017)

• Japan Society of Monetary Economics in Tokyo (May 2018)

• 8th International Conference of the Financial Engineering and Banking Society in Rome (Jun 2018)

• 30th Asian Finance Association in Tokyo (June 2018)

• 48th Japanese Association of Financial Econometrics and Engineering in Tokyo (Mar 2018)