We investigate the determinants of the term structures of market liquidity and bond yield in the case of the Quantitative Easing (QE) programs implemented by the Bank of Japan (BoJ). We distinguish between two opposing effects of QE on the liquidity of Japanese Government Bonds, the "scarcity effect," which is gradually manifested as a negative impact on liquidity, due to the shrinkage in the available supply of bonds; and the "spotlight effect," which induces an immediate improvement in liquidity, reflecting BOJ's massive demand. Between 2011 and 2016, we find that government bonds show an improvement in liquidity through the spotlight effect, but also experience a deterioration in liquidity through the scarcity effect. As for the yield, both the spotlight and scarcity effects work in the same direction (i.e., they raise bond prices) against theoretical expectation. Illiquidity caused by scarcity amplifies the yield decline rather than adding to the illiquidity premium.
Keywords: Sovereign Bonds; Quantitative Easing; Market Liquidity; Scarcity; Spotlight
Views expressed in the paper are those of the authors and do not necessarily reflect those of the Bank of Japan or Institute for Monetary and Economic Studies.