Jean-Sébastien is a Senior Research Advisor in the Financial Markets Department. His research covers a range of topics in US and Canadian fixed income markets, including the economic determinants of long-term interest rates, the interaction between repo and spot bond markets as well as the role of funding conditions for market liquidity. Jean-Sébastien received his PhD in economic from the Université de Montréal.
Staff analytical notes
“Reach for yield”—This is the commonly heard explanation for why pension plans shift their portfolios toward alternative assets. But we show that the new portfolios also hold more bonds, offer lower average returns and produce smaller and less volatile solvency deficits. These shifts are part of a broader strategy to reduce solvency risk.
The TSX index rose by 9.5 percent in November 2020, adding large gains to an already sharp V-shaped recovery. The economic outlook improved at that time as well. We ask whether the stock market gains since last autumn are due to improving forecasts of firms’ earnings.
Between February 19 and March 23, 2020, the Canadian stock market plunged due to the severe economic impact of COVID-19. By the end of the summer, the stock market had already recovered a significant portion of its losses, leaving many asking if investors see the economy through rose-coloured glasses. Despite these concerns, we find that current market valuations for companies on the Toronto Stock Exchange align well, on average, with the declines in earning forecasts observed since the start of the year. We also find these market valuations are consistent with the discount rate returning to its pre-pandemic level.
Bond dealers have traditionally kept bonds in an inventory until clients buy them. But now, dealers have another way to access bonds for their clients: the exchange-traded fund. We discuss this new way to manage bond dealing and what it might mean for bond markets.
The disruption due to COVID-19 reverberated through the bond markets in three phases. In the first phase, dealers met the rising demand for liquidity. In the second, dealers reduced the supply of liquidity, and trading conditions worsened significantly. Finally, the market returned to relative stability following several interventions by the Bank of Canada.
Government of Canada bonds in circulation that promise very similar payoffs can have different prices. We study the reason for these differences. Bonds that trade more often and earn high rental income in the repurchase agreement (repo) market tend to have higher prices. Bonds with longer tenors and times to maturity tend to have lower prices. This contrast between cheap and expensive bonds is important because trading volume and rental income can change rapidly, unlike tenor and time to maturity, which are stable.
Price controls, or caps, can lead to shortages, as 1970’s gasoline price controls illustrate. One million trades show that the market for borrowing bonds in Canada has an implicit price cap: traders are willing to pay no more than the overnight interest rate to borrow a bond. This suggests the probability of a shortage increases when interest rates are very low.
Canadian interest rates show a secular decline since the 1980s. Long-term survey-based forecasts of interest rates also declined, but less so and were more gradual. Our model-based estimates show an endpoint shifting over time in three phases: a decline between 1990 and 1995, a period of stability between 1996 and 2007, and a further decline since 2008. The current endpoint estimate remains clouded with uncertainty; this is an active area of research.
We identify a few Bank of Canada press releases that had the largest immediate impact on the exchange rate market. We find that volatility increases after these releases, but the effect is short-lived and mostly dissipates after the first hour, on average. Beyond the first hour, the size of the effect is similar to what we observe for other economic releases, such as those for inflation or economic growth data.
We draw a parallel between the dramatic increases of systematic variations in exchange rates and international bank lending. We find that when a country’s currency has a larger share of systematic variations, lending flows by international banks to that country become more sensitive to global lending - they also become more systematic. This parallel is particularly prevalent for large commodity exporters, including Canada. Global financial intermediation may open a new channel between the real economy and exchange rates.
Staff discussion papers
One year later, we review the events that took place in Canadian fixed-income markets at the beginning of the COVID-19 crisis and propose potential policy research questions for future work.
This paper investigates how a low or negative overnight interest rate might affect the Canadian repo markets. The main conclusion is that the repo market for general collateral will continue to function effectively.
Staff working papers
We investigate the economic forces behind the secular decline in bond yields. Before the anchoring of inflation in the mid-1990s, nominal shocks drove inflation, output and bond yields. Afterward, the impacts of nominal shocks were much less significant.
Dealers connect investors who want to buy or sell securities in financial markets. Over time, dealers and investors form trading networks to save time and resources. An emerging field
of research investigates how networks form.
Specifications of the Federal Reserve target rate that have more realistic features mitigate in-sample over-fitting and are favored in the data.
We study settlement fails for trades in the Government of Canada bond market. We find that settlement fails do not occur independently. Using a novel and comprehensive dataset, we examine three drivers of fails.
We use relative value to measure limits to arbitrage in fixed-income markets. Relative value captures apparent deviations from no-arbitrage relationships. It is simple, intuitive and can be computed model-free for any bond.
The uncertainty around future changes to the Federal Reserve target rate varies over time. In our results, the main driver of uncertainty is a “path” factor signaling information about future policy actions, which is filtered from federal funds futures data.
We introduce a new framework that facilitates term structure modeling with both positive interest rates and flexible time-series dynamics but that is also tractable, meaning amenable to quick and robust estimation.
Following theory, we check that funding risk connects illiquidity, volatility and returns in the cross-section of stocks. We show that the illiquidity and volatility of stocks increase with funding shocks, while contemporaneous returns decrease with funding shocks.
Cochrane and Piazzesi (2005) show that (i) lagged forward rates improve the predictability of annual bond returns, adding to current forward rates, and that (ii) a Markovian model for monthly forward rates cannot generate the pattern of predictability in annual returns.
Most central banks effect changes to their target or policy rate in discrete increments (e.g., multiples of 0.25%) following public announcements on scheduled dates. Still, for most applications, researchers rely on the assumption that the policy rate changes linearly with economic conditions and they do not distinguish between dates with and without scheduled announcements.
Bank of Canada Review articles
May 11, 2017
How do unconventional monetary policies like quantitative easing and negative interest rates affect domestic financial conditions and the broader economy in small open econo-mies, such as Canada? These policies are effective in depreciating the exchange rate in small open economies, while lower interest rates are also passed through to the economy, albeit only partially. When conventional monetary policy is close to its limits, fiscal policy may be a more important complement to monetary policy in a small economy, particularly if global demand for safe assets compresses long-term interest rates.
November 15, 2012
Central counterparties can make over-the-counter markets more resilient and reduce systemic risk by mitigating and managing counterparty credit risk. These benefits are maximized when access to central counterparties is available to a wide range of market participants. In an over-the-counter market, there is an important trade-off between risk and competition. A model of an over-the-counter market shows how risk and competition could be influenced by the incentives of market participants as they move to central clearing. In a centrally cleared market, there may be less risk when participation is high. This helps to explain why regulators have put in place requirements for fair, open and risk-based access criteria.
Financial System Review articles
June 9, 2016
This report investigates how the markets for repurchase agreements and securities-lending agreements support the liquidity of Canadian bond markets. It also discusses how recent regulatory changes, as well as low interest rates and settlement failures, are potentially affecting securities-financing markets and, as a result, bond market liquidity.
- "Bond Liquidity Premia"
(with R. Garcia), Review of Financial Studies. (2012)
- "Risk Premium, Variance Premium and the Maturity Structure of Uncertainty",
(with B. Fenou, A. Taamouti and R. Tédongap), Review of Finance, (2013)
- "Non-Markov Gaussian Term Structure Models : The Case of Inflation",
(with B. Fenou), Review of Finance. (2014)
- "Bond Risk Premia and Gaussian Term Structure Models",
(with B. Feunou), Management Science. (2018)
- "Measuring Limits of Arbitrage in Fixed-Income Markets",
(with G. Nolin), The Journal of Financial Markets. (2019)
- "What Model for the Target Rate",
(with B. Feunou and J. Jin), Studies in Nonlinear Dynamics & Econometrics. (2020)