The Use of the Black Model of Interest Rates as Options for Monitoring the JGB Market Expectations

This paper analyzes the Japanese government bond (JGB) yield curve using the Black-Gorovoi-Linetsky (BGL) model of interest rates as options with a view to monitoring the JGB market expectations about the Bank of Japan's (BOJ) zero interest rate policy (ZIRP). Main findings are as follows. First, overall fitting performance of the BGL model is much better than that of the original Vasicek model in our sample period from the start of the quantitative monetary easing policy on March 19, 2001 through the end of the ZIRP on July 14, 2006. Second, the shadow interest rate is estimated to be negative throughout the period and rise toward zero quite recently. Third, the first hitting time until the negative shadow interest rate first hits zero shows a very good performance in predicting the ending time of the ZIRP with an error of only about one month. Fourth, the estimated probability density function of the first hitting time shows that the JGB market expectations rapidly converge to the mode value as the ending time of the ZIRP approaches.