A Note on Modelling Yield Curve Control : A Target-Zone Approach

Yield curve control (YCC) allows central banks to control long-term interest rates within a pre-announced trading band to complement traditional monetary policy. This note uses a target-zone model developed for exchange rates to study the bond yield movements under YCC. The bond yield is assumed to be quasi-bounded in a band, but can breach a cap under a restricted condition of the relationship between the parameters of the drift term and the stochastic part of the bond yield dynamics. The empirical results using market data of the 10-year Japanese Government Bonds (JGB) from 5 August 2016 – 28 May 2021 suggest that this model can describe the JGB yield dynamics under YCC, in which the drifting force is a decreasing function of the US Treasury yield, indicating co-movement in the global bond market. While the JGB yield was bounded below the caps during most of the time, as indicated by its dynamics, the conditions for breaching the caps were met in October 2018 and March 2021 using only information until those points, i.e., about two months after and one week before the two respective band widenings