Research Report - Pricing Performance 3Q 2010

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Pricing Performance Evaluation for Third Quarter Period from 1 July 2010 to 30 September 2010: An Empirical Study

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Bond Pricing Agency Malaysia Research Series

PRICING PERFORMANCE EVALUATION

FOR THIRD QUARTER PERIODFROM 1 JULY 2010 TO 30 SEPTEMBER 2010:AN EMPIRICAL STUDY

October 2010

Pok Sheau Tzian

[email protected]

Paige Tan

[email protected]

Simon Ng Sean Cho

[email protected]




1 Introduction

This paper documents Bond Pricing Agency Malaysia’s (“BPA Malaysia”) pricing performance for the third

quarter of 2010 (“3Q 2010”) for market reference purposes. The period of assessment is from 1 July 2010to 30 September 2010. Comparisons were also made against the preceding period (“2Q 2010”).

2 Pricing Performance Methodology

The premise of BPA Malaysia’s pricing performance measurement lies in its level of reliability. Two

statistical approaches were utilized in this report to assess BPA Malaysia’s pricing performance: scatter

plot analysis and distribution diagram study.

The scatter plot analysis is conducted to determine the relationship between mark-to-market (“MTM”)prices valued by BPA Malaysia and the actual traded price (yield basis). The analysis draws the

conclusion of the degree of relevance of BPA Malaysia’s MTM levels towards the corresponding traded

yield levels.

Assuming a sufficient sample size, the test of accuracy entails looking at the distribution of the difference

between BPA Malaysia’s MTM and the traded yield. The distribution diagram generated would then be

subjected to the test of normality. The assumption of any good predictor is a bell curve normally

distributed around zero. The tighter the curve implies a better predictor. If a vertical line is obtained, it

means a perfect predictor has been achieved.

In reality, the likelihood of obtaining a perfect predictor is quite extreme. In the Malaysian bond market,

not all trades registered with the official data capturing mechanism, Electronic Trading Platform or

commonly known as ETP can be construed as valid trades. Due to Malaysia’s bond market structure, it is

still possible for unusual transactions that are deemed as non-valid trades to be reported in the ETP.

Some examples of non-valid trades are (i) non-standard lot trades; and (ii) off-market level prices among

others. For completeness, this study will exclude these non-standard lot trades and outliers1 (please refer

to the Appendix for a list of the outliers).

1 This analysis excludes the outliers’ trades, where (MTM - Trade Level) is more than ±100 basis points (bp) where its

extreme tail distribution plots affect the quality of BPA Malaysia’s pricing accuracy

Bond Pricing Agency Malaysia Research SeriesOctober 2010




3 Empirical Study

3.1 Scatter Plot Analysis

The scatter diagram below plots the current quarter’s traded yields (x-axis) against BPA Malaysia’s MTM

levels for the respective trades (y-axis).

Figure 1: Traded Yield vs BPA Malaysia’s MTM (1-July-10 to 30-Sep-2010)

Source: BPAM

The line in Figure 1 represents the best fit linear relationship of all the data points in the diagram. Where

all traded yields for the quarter have been marked, the equation is as follows:

As seen in Figure 1, the relationship between BPA Malaysia’s MTM levels and the traded yields is

represented by the straight line with the following equation:


Y = X

Where, Y = BPA Malaysia’s MTM (%)

X = Traded Yield (%)





Y = 0.9968X (R2 = 0.9924)






3.2 Distribution Diagram Analysis

The sample size for 3Q 2010 of 1560 data points was sufficiently large to generate a distribution diagram

(Figure 2). Based on this sample size, 73.27% of the trades were accurately marked2. For the ±20bp

target band, BPA Malaysia was able to correctly place the pricing 99.36% of the time period under review.

The following Table 2 shows the statistical comparison of pricing performance between 2Q 2010 and 3Q

2010.

Table 2: Statistical comparisons

Factor 2Q 2010 3Q 2010

Sample size 1502 1560

Average spread -3bp -2bp

Maximum spread 38bp 34bp

Minimum spread -93bp -62bp

Standard deviation 8.34bp 4.73bp

Variance 69.49 22.40

Target band accuracy (±20bp) 96.40% 99.36%

Effectiveness ratio3

72.08 22.55

As observed from the table above, an improvement was noted in the statistics as there was less data

“noise” affecting the entire population of the data. Standard deviation was seen lower by approximately

4bp compared to 2Q 2010, while the target band accuracy of ±20bp has increased by 2.96%. This has

translated to a better variance reading and hence an improved effectiveness ratio3 for 3Q 2010.

2

Accurately marked trades band are inclusive of (MTM-Trade) values of ±1 to account for rounding adjustments

3 In terms of efficiency, we would utilise the Effectiveness Ratio, a ratio that is defined as:

AccuracyBand

VarianceRatioessEffectiven =

This ratio indicates the variance per unit of accuracy . On a relative standing, a low ratio means that the sample is

more effective as it implies (MTM - Trade) are converging to zero.





Figure 2: Distribution MTM-Trade for total population excluding outliers (1-July-10 to 30-Sep-10)

Source: BPAM

For 3Q 2010, we observed that the distribution of MTM - Trade skewed slightly towards the left in Figure

2. To further explain the skewness of the distribution, we have further segregated the MTM-Trade for totalpopulation pool into 2 main categories:

(i) Private Debt Securities (PDS); and

(ii) Government bonds.





3.2.1 Private Debt Securities (PDS)

Figure 3: Distribution MTM-Trade for PDS excluding outliers (1-July-10 to 30-Sep-10)

Source: BPAM

As seen in the distribution diagram above, BPA Malaysia has placed 92.71% of evaluated PDS MTM

levels within the traded yield level of ±1 bp region for 3Q2010. Only less than 0.59% of the time under

review that BPA Malaysia has placed its PDS MTM levels more than ±20 bp from the traded yield levels

observed from the market. The shape of the distribution diagram in Figure 3 is symmetrical and it is not

the cause of the skewness as observed in Figure 2.





3.2.2 Government Bonds

Figure 4: Distribution MTM-Trade for Government bonds excluding outliers (1-July-10 to 30-Sep-10)

Source: BPAM

Figure 5: Breakdown and comparison of MTM-Trade pool for Off-the-run Government bonds and On-the-run Governmentbonds from 1-July-10 to 30-Sep-10

Source: BPAM





As illustrated from Figure 4, distribution diagram for the MTM-Trade pool for the government bonds skews

slightly to the left when compared to the distribution diagram for the MTM-Trade pool for all segments in

Figure 2. Here, only 49.93% of government bond trades were accurately marked to traded yield level of

±1 bp region. Further breakdown in the MTM-Trade pool for government bonds as illustrated in Figure 5

suggested the cause of the skewness to the left of the diagram in both of the distribution diagrams of

Figure 2 and Figure 4 were caused by off-the-run government bonds, where the off-the-run government

bonds were usually traded higher in terms of yield as compared to BPA Malaysia’s daily mark-to-market

yield4. The slight skewness to the left reflects the higher frequency of trades that falls within the range of

-10<=x<-1.

Figure 6 provides statistics analysis of accounted trades for current and previous quarters under review.

The total number of accounted trades for the on-the-run government bonds has significantly increased by

5.16% to 22.40% in 3Q 2010 when compared to 17.24% in the preceding quarter. Simultaneously, the

trades for the off-the-run government bonds’ has decreased by 13.16% to 13.78% for 3Q 2010 (2Q 2010:

26.94%).

Figure 6: Statistics of accounted trades

Source: BPAM

4 The MTM for off-the-run government bonds are based on BPA Malaysia’s government benchmark curve, where the

curve is generated from on-the-run government bonds. Due to liquidity premium, off-the-run government papers areusually viewed cheaper relatively to the on-the-run papers thus translating to higher yield. The fair valuation nature of pricing that BPA Malaysia imposes, which conforms to the law of one price methodology for the government papers,does not recognize the higher traded off-the-run government bonds (i.e yield terms).


Breakdown of Trade Volume for the MTM – Trade for 2Q 2010 and 3Q 2010






5 Appendix

3Q 2010 (MTM-Trade >±100bp)

No. Product Code Bond Name Bond Class Trade Date MTM-Trade

1. VK10011311052017BORCOS RM45.0 Million GSIM - Tranche 3(Series 2)

LT Islm-Corp Guaranteed-AAA 11/08/2010 133

2. VK10011411052017 BORCOS RM30.0 Million GBAIS 11/05/2017 LT Islm-Corp Guaranteed-AAA 11/08/2010 133

Disclaimer

Information on this document is intended solely for the purpose of providing general information on the

Ringgit Bond market and is not intended for trading purposes. The information contained within is not

intended to be an exhaustive or complete coverage of the subject(s). None of the information constitutes

a solicitation, offer, opinion, or recommendation by Bond Pricing Agency Malaysia Sdn Bhd to buy or sell

any security, or to provide legal, tax, accounting, or investment advice or services regarding the

profitability or suitability of any security or investment. Investors are advised to consult their professionalinvestment advisors before making any investment decision. Materials provided on this document are

provided on an "as is" basis, and while care has been taken to ensure the accuracy and reliability of the

information provided in this document, Bond Pricing Agency Malaysia Sdn Bhd (BPA Malaysia) provides

no warranties or representations of any kind, either express or implied, including, but not limited to,

warranties of title or implied warranties of fitness for a particular purpose, accuracy, correctness, non-

infringement, timeliness, completeness, or that the information is always up-to-date.


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Research Report - Pricing Performance 3Q 2010