ECONOMIC GROWTH CENTER
                                
                        YALE UNIVERSITY
                                
                                
                        P.O. Box 208269
                      27 Hillhouse Avenue
               New Haven, Connecticut 06520-8269
                                
                                
                                
                                
                CENTER DISCUSSION PAPER NO. 800
                                
                                
                                
                                
       INTEREST RATE SMOOTHING AND TIME-VARYING PREMIUM:
            ANOTHER LOOK AT DEBT MANAGEMENT IN JAPAN
                                
                                
                                
                                
                                
                                
                         Yosuke Takeda
         Yale University and Sophia University (Japan)
                                
                                
                                
                                
                           April 1999

     



 Note:  Center Discussion Papers are preliminary materials circulated to stimulate discussions and critical
        comments.



     Interest Rate Smoothing and Time-Varying Term Premium:
            Another Look at Debt Management in Japan
                                
                                
                        Yosuke Takeda *
                                
        Yale University and Sophia University (Japan) **  
                                
                          June 1, 1999
                                
                            Abstract

We argue a source of time-varying premium (TVTP) in Japanese government bond market, and show that
it is interest rate smoothing that causes empirical failures of expectation theory of term structure of interest
rates.  We estimate a regime switching ARCH model where an interest rate smoothing regime can be
identified.  Based on a model of time-inconsistency by Missale and Blanchard (1994), we further focus on
a role of debt maturity in TVTP, which is an alternative to an ARCH process.
     Our robust empirical evidences support the expectation theory in Japanese government bond
market.  Moreover, in comparison with the ARCH process, debt maturity turns out to be a reliable proxy
for the TVTP.  This shows a possibility of a debt management policy in Japan: fiscal authority takes
advantage of the debt maturity for price stability which is a target of monetary policy.  It sharply contrasts
with an evidence for ineffectiveness of the U.S. debt management policy by Wallace and Warner (1996).

Key Words: Time-Varying Term Premium, Interest Rate Smoothing, Regime Switching ARCH Model,
Debt Maturity, Reputation Equilibrium.

JEL Classification Codes: E42, E43, E52.
_________________________________________
   *Correspondence: Yosuke Takeda, Visiting Research Fellow, Economic Growth Center, Department of
Economics, Yale University, 27 Hillhouse Avenue, P.O. Box 208269, New Haven, CT 06520-8269. E-mail: y-
takeda@hoffman.cc.sophia.ac.jp or takeda@econ.yale.edu.
    **This paper was partly written when I stayed as a visiting research fellow at Economic Growth Center, Yale
University from 1998 to 1999.  I am grateful to Kazumi Asako, Michael Bordo, Shin-ichi Fukuda, Koichi Hamada, Jyuro
Teranishi and seminar participants at Hitosubashi University (Japan) and Rutgers University for many valuable
suggestions and comments, and to Deborah Tenney for editorial contributions.