Bond Lending and the Law of One Price in China's Treasury Markets

38 Pages Posted: 25 Jan 2021

See all articles by Jacopo Magnani

Jacopo Magnani

EMLYON Business School

Yabin Wang

Hong Kong Monetary Authority

Date Written: December 29, 2020

Abstract

This paper examines how the introduction of bond lending in China's bond market has affected violations of the law of one price, measured by the yield spread between similar treasury bonds. To identify the effect of bond lending, we exploit the fact that in China identical bonds are traded on two segmented markets and bond lending has been introduced in only one of the two markets. We find that the introduction of bond lending has led to a decline in deviations from the law of one price. Consistent with an interpretation based on limits to arbitrage, a significant fraction of the deviations from the law of one price in our sample represent actual profit opportunities and the introduction of bond lending has reduced arbitrage profits.

Keywords: China’s Bond Markets, Bond Lending, Law of One Price

JEL Classification: G12

Suggested Citation

Magnani, Jacopo and Wang, Yabin, Bond Lending and the Law of One Price in China's Treasury Markets (December 29, 2020). Available at SSRN: https://ssrn.com/abstract=3756891 or http://dx.doi.org/10.2139/ssrn.3756891

Jacopo Magnani (Contact Author)

EMLYON Business School

23 Avenue Guy de Collongue
Ecully, 69132
France

Yabin Wang

Hong Kong Monetary Authority ( email )

Hong Kong

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