Research On Arbitrage And Risk Management In Chinese Inter-bank Bond Market

The Chinese inter-bank bond market was established in 1997, during the past 16 years, it has grown to a regulated over-the-counter market for institutions and the main body of Chinese bond market, playing an increasingly important role in Chinese financial system. Our inter-bank bond market has been the platform where the authority executes monetary and fiscal policies, where the People’s Bank of China conducts open market operations, issues Central Bank Bills to offset liquidity and manages cash of the national treasury, and where the treasury issues national debt. Our inter-bank bond market thrives to be the channel for improving national resources distribution and stimulating the economy by launching various kinds of financial instruments for enterprises to raise money directly. Our inter-bank bond market is also essential for financial institutions because different kinds of securities and their derivatives traded here present market participants with more choices to invest, which makes their management of assets and liabilities more flexible.Arbitrage discussed in this paper is a generalized type, which requires some initial investments and is not fully risk free. Investors should take advantage of market inefficiency and construct opposite positions in two (or more) securities (or portfolios) or in different markets where prices deviate abnormally, considering transactional costs, undertaking liquidity risk、counterparty risk、market risk and other kinds of risks, and finally make a profit. These arbitrage transactions will improve the efficiency and liquidity of our inter-bank bond market, make it maturer and more rational, promote innovations and provide investors with more investment opportunities.I begin with a summary of the characteristics of Chinese inter-bank bond market, introducing its history and operational system briefly, and then from the perspective of market participants, I explore three types of arbitrage in the Chinese inter-bank bond market, including inter-market arbitrage, cross-species arbitrage and inter-temporal arbitrage. Firstly, I construct the model using theoretical methods, and then, I test the model using samples which consist of treasury bonds, financial bonds and enterprise bonds, finally I calculate their profits. All these arbitrage models are dependent on the skill and experience of investors, on a revised arbitrage model and process, and on the recognition and management of risks. Thus, I explain the main risks associated with the inter-bank bond market arbitrage, they are interest rate risk, liquidity risk, credit risk and operational risk. Then I point out existed systems which aim to reducing risks and propose to further improve the level of risk management in the inter-bank market. Finally, I make suggestions to investors.I believe there exists opportunities of all the three types of arbitrage in our inter-bank bond market, but each has its own application conditions. Investors can choose the most suitable one regarding to their ability to take risks, their capabilities, the source and amount of their money, their investment horizon and their investment objective, take care of risks, then they may make money and meanwhile improve market efficiency and liquidity.