Research On The Microstructure Of China's Bond Market

The Chinese Bond Market has developed rapidly in recent years.To the end of 2017,the total outstanding amount is 7.3 trillion Yuan,among which 1.7 trillion are bonds issued by non-financial corporates.The Chinese Bond Market is now the third largest bond market and the second largest corporate bond market in the world.Besides the rapid growth in volume,the variety of bonds is much wider and now similar with those in developed countries,investors are becoming more diversified and the infrastructure and information technology is advanced.Bond market has becoming one of the most important channels for government and corporations to borrow money as well as the largest financial market for institutional investors.Building a well-functioned bond market is crucial to implementing resource allocation,the key role of the capital market.A well-functioned bond market is also critical to the deepening of the market-oriented reform in interest rates and the opening of Chinese financial markets as well as RMB internationalization.For issuers and investors,it is important to understand how the credit spread of a bond is determined and what affects the liquidity of a bond.For regulators,it is important to evaluate and know how to improve the efficiency and fairness of the bond market.The answer to the above questions lies in the field of the market microstructure theory.In classic price theory,the price of a good is determined by its demand and supply in a Valrasian market with no transaction cost and the trading procese is treated as a black box.However,there are trading frictions and asymmetric information in the real market.By investigating the transaction frictions under specific trading rules and participants structures,market microstructure theory contributes to a better understanding of the price formation process and a method to evaluate the efficiency and the fairness of the financial market.Since the 1960 s,the market microstructure theory has made substantial progresses and promoted other related areas,such as asset pricing,corporate finance and international finance.Focusing on the microstructure has both pros and cons.There has been none uniform theory yet for all securities among different countries.Most literature in market microstructure theory focused on the United States.The bond market of United States is a typical OTC dealer market and can be split into several dealer-to-clients markets and an inter-dealer market.The dealer-clients markets are quote-driven and the inter-dealer market is order-driven,and both are fragmented and of low transparency.However,the bond market in China is fundamentally different from the United States',which means the traditional bond market microstructure theory can not be simply applied to the Chinese bond market.To solve this problem,this paper expands the connotation of the microstructure theory in two ways.First,it expands the trading process to include the process of information interaction befor trading execution and the process of trading report,clearing and settlement after trading execution.Second,more emphasis is put on the participants' and products' structure,especially their heterogeneity.With these expansions,it could be better illustrated that the Chinese bond market is a centralized,order-driven market with high degree of transparency.By comparing the microstructural differencies,it is pointed out that the Chinese bond market is not less developed than the Uninted States.To the contrary,the Chinese bond market is generally more effective,more transparent,and fairer in many aspects.After the demonstration of the microstructural feature of the Chinese bond market,the paper investigates three areas as application and empirical analysis.First,the paper uses the real trading data to compute liquidity indicators of the market,constructs a liquidity composite index,and analyzes how microstructural factors affect market liquidity.Secondly,the paper analyzes how microstructural factors affect credit spreads,and explains the pro-cyclical phenomenon of the credit spreads.Finally,the paper analyzes why investor protection is especially important in the Chinese bond market and how to improve it to get prepared for no more bail out.In conclusion,this paper enlarges the scope and methodology of the market microstructure theory.It provides a deeper understanding of the Chinese bond market and helps participants to participate and develop the Chinese bond market.