Primary Auction Mechanics
Understanding auction types, competitive vs non-competitive bidding, and the primary market issuance process
How JGBs Are Sold: The Auction Process
JGBs are sold in the primary market through auctions conducted by the Bank of Japan (BOJ) on behalf of the Ministry of Finance (MOF). Understanding this process is key to interpreting market demand and short-term price movements.
Auction Types: Price vs. Yield
The MOF uses two main auction methods depending on the JGB maturity. Understanding the difference between JGB auctions and other major government bond markets is crucial for international investors.
JGB vs. UST Auction Format Comparison
Two dominant government bond markets, two different auction philosophies
How It Works:
- Bidders submit price offers (or yields for T-Bills)
- Bids accepted from highest price down
- Each winner pays their bid price (discriminatory pricing)
- Example: Bid ¥100.50, you pay ¥100.50. Bid ¥100.20, you pay ¥100.20.
Strategic Implication:
Bidders engage in bid shading—bidding below true valuation to avoid overpaying (winner's curse). This can reduce government revenue.
Used For:
All coupon-bearing JGBs (2Y, 5Y, 10Y, 20Y, 30Y, 40Y)
How It Works:
- Bidders submit yield offers (lower yield = higher price)
- Bids accepted from lowest yield up
- All winners pay the same price (uniform pricing = highest accepted yield)
- Example: Bid 4.20% and bid 4.50%, but clearing yield is 4.55%. Both pay the price corresponding to 4.55%.
Strategic Implication:
Reduces incentive to shade bids—safer to reveal true demand. Theoretically increases government revenue and participation.
Used Since:
1998 (experiment began 1992); fully adopted by 2003 after Salomon Brothers squeeze scandal
Why Does Japan Still Use Multi-Price?
| Consideration | Japan's Rationale |
|---|---|
| Market Stability | JGB market has functioned well for decades under multi-price. "If it ain't broke, don't fix it." |
| Dealer Preference | Primary dealers familiar with current system. Format change would require retraining, system updates, and risk disruption. |
| Price Discovery | Multi-price auctions reveal more information about demand distribution (bid dispersion visible in results). |
| Revenue Difference Minimal | Empirical studies (Ishida & Hattori 2020) show revenue difference between formats is <1bp in stable markets. Not worth transition risk. |
| 40Y Exception | Japan does use single-price (yield) format for 40Y bonds due to thin market and liquidity concerns—showing willingness to adapt format when needed. |
JGB Auction Formats: Price vs. Yield
Japan uses two different auction formats depending on the security type. Both are multi-price (conventional), but they differ in what bidders submit and how payments are calculated.
Used For: All coupon-bearing JGBs (2Y, 5Y, 10Y, 20Y, 30Y, 40Y) and Inflation-Indexed Bonds
How It Works:
- Bidders submit price bids (e.g., ¥100.25 per ¥100 face value)
- Bids accepted from highest price down until offering amount filled
- Each winner pays their own bid price (multi-price/discriminatory)
Worked Example: 10-Year JGB Price Auction
Auction Setup:
- Security: 10-Year JGB (Issue #385)
- Amount Offered: ¥800 billion
- Auction Date: December 5, 2024
Competitive Bids Submitted:
| Dealer | Price Bid (per ¥100) | Amount (¥ billions) | Cumulative (¥ billions) | Status |
|---|---|---|---|---|
| Nomura | ¥100.35 | ¥200 | ¥200 | ✅ Accepted |
| Daiwa | ¥100.32 | ¥150 | ¥350 | ✅ Accepted |
| SMBC Nikko | ¥100.28 | ¥250 | ¥600 | ✅ Accepted |
| Mizuho | ¥100.22 | ¥200 | ¥800 | ✅ Accepted (Stop Price) |
| Mitsubishi UFJ | ¥100.18 | ¥300 | ¥1,100 | ❌ Rejected |
| MUFG | ¥100.15 | ¥150 | ¥1,250 | ❌ Rejected |
Auction Results:
Highest Accepted: ¥100.35
Weighted-Average Price: (200×100.35 + 150×100.32 + 250×100.28 + 200×100.22) / 800 = ¥100.29
Total Bids: ¥1,250 billion
Bid-to-Cover Ratio: 1,250 / 800 = 1.56x
Who Pays What:
- Nomura pays ¥100.35 per ¥100 (their bid) × ¥200B = ¥200.7B total
- Daiwa pays ¥100.32 × ¥150B = ¥150.48B
- SMBC Nikko pays ¥100.28 × ¥250B = ¥250.7B
- Mizuho pays ¥100.22 × ¥200B = ¥200.44B
Key Point: Each winning dealer pays a different price—their own bid. Nomura paid 13 sen more per ¥100 than Mizuho for the same bond.
Used For: Treasury Discount Bills (T-Bills) only
How It Works:
- Bidders submit yield bids (e.g., 0.250% annual)
- Bids accepted from lowest yield up (lower yield = higher price = more revenue for MOF)
- All winners pay the same price, calculated from the highest accepted yield
Worked Example: 6-Month T-Bill Yield Auction
Auction Setup:
- Security: 6-Month Treasury Bill
- Amount Offered: ¥500 billion
- Auction Date: December 10, 2024
Competitive Bids Submitted:
| Dealer | Yield Bid (%) | Amount (¥ billions) | Cumulative (¥ billions) | Status |
|---|---|---|---|---|
| Mizuho | 0.120% | ¥150 | ¥150 | ✅ Accepted |
| Nomura | 0.135% | ¥200 | ¥350 | ✅ Accepted |
| SMBC | 0.150% | ¥150 | ¥500 | ✅ Accepted (Stop Yield) |
| Daiwa | 0.165% | ¥100 | ¥600 | ❌ Rejected |
Price Calculation from Stop Yield:
Days to Maturity: 182 days
Discount Formula: Price = 100 - (Yield × Days / 365)
Calculation: Price = 100 - (0.150 × 182 / 365) = 100 - 0.0748 = ¥99.9252 per ¥100
Who Pays What:
- Mizuho pays ¥99.9252 × ¥150B = ¥149.888B (even though they bid 0.120%)
- Nomura pays ¥99.9252 × ¥200B = ¥199.850B (even though they bid 0.135%)
- SMBC pays ¥99.9252 × ¥150B = ¥149.888B (bid matched stop)
Key Point: All winners pay the same price, determined by the stop yield. This is single-price (Dutch) pricing for T-Bills, different from multi-price for coupon bonds.
The Bidding Process
Bids are submitted electronically to the BOJ during a specified time window on the auction day. Participants are split into two groups.
1. Competitive Bidding
This is the main auction, open to Primary Dealers and other major financial institutions.
- How it works: Bidders submit one or more bids specifying both the price they are willing to pay and the amount they wish to buy.
- Allocation: The MOF starts with the highest price bid and accepts bids in descending order until the total amount of the auction is allocated. The lowest successful price is called the "lowest accepted price" or "stop price."
- Who uses it: Professional dealers and investors who have a strong view on what the bond is worth. Their goal is to buy the bond as cheaply as possible, but high enough to ensure their bid is accepted.
2. Non-Competitive Bidding ("Non-Comps")
This is a smaller bidding window open to a wider range of investors who want to buy bonds without guessing the price.
- How it works: Bidders submit a bid specifying only the amount they wish to buy.
- Allocation: Non-competitive bidders are guaranteed to have their bids filled (up to a certain limit). The price they pay is the weighted-average price of all accepted competitive bids.
- Who uses it: Smaller investors, regional banks, or anyone who prioritizes securing the bonds over getting the best possible price. They are "price takers."
How to Read JGB Auction Results
Immediately after an auction, the MOF publishes the results on their official website. These are scoured by traders for clues about market health and demand. Below is an actual recent 10-year JGB auction result showing what the key terms mean.
Source: Ministry of Finance - Official Auction Results
| Auction Metric | Result |
|---|---|
| Amount Offered | ¥2,009.9 billion |
| Total Bids Received | ¥6,704.3 billion |
| Amount Accepted (Competitive) | ¥1,420.3 billion |
| Non-Competitive Bids | ¥0.363 billion |
| Non-Price Competitive Bids | ¥589.2 billion |
| Bid-to-Cover Ratio | 3.34x (¥6,704.3 / ¥2,009.9) |
| Lowest Accepted Price (Stop Price) | ¥100.36 per ¥100 face value |
| Weighted-Average Price | ¥100.55 per ¥100 face value |
| Price "Tail" | 0.19 (¥100.55 - ¥100.36) |
| Yield at Stop Price | 1.657% |
| Yield at Weighted-Average | 1.635% |
Key Metrics Explained
- Bid-to-Cover Ratio
- Calculation: (Amount of Bids) / (Amount Offered)
- What it means: The most common measure of demand. A high ratio (e.g., > 3.0x) is strong, showing bidders tried to buy many times more bonds than were for sale. A low ratio (e.g., < 2.5x) signals weak demand.
- The "Tail"
- Calculation: (Weighted-Average Price) - (Lowest Accepted Price)
- What it means: This is the most important metric for professionals. It measures the weakness of demand.
- A small tail (e.g., 0.01 or 0.00) is very strong. It means all bids were clustered tightly around a high price.
- A large tail (e.g., 0.04 or more) is very weak. It means that to sell the full amount, the MOF had to accept low-ball bids far away from the average, indicating demand was poor.
- Lowest Accepted Price ("Stop Price")
- What it means: The clearing price of the auction. This price (and its corresponding yield) immediately becomes the new benchmark for secondary market trading.
Settlement
All JGB auctions settle on the business day *after* the auction, known as T+1. Payment and delivery are handled electronically through the BOJ's "Book-Entry System for JGBs" (part of the BOJ-NET system).
Settlement: Clean Price vs Dirty Price
After the auction, winning bidders must settle their purchase. Understanding how bonds are priced and settled is critical for anyone trading JGBs.
The Problem: Who Gets the Coupon?
Bonds pay coupons semi-annually, but they trade every single day. This creates a problem: what happens if you sell a bond just one day before the coupon is paid?
It would be unfair for the new buyer to receive the *entire* 6-month coupon payment after holding the bond for only one day. Likewise, it would be unfair for the seller, who held the bond for 5 months and 29 days, to receive *nothing*.
The market solves this with a system that separates the bond's quoted price from the interest it has earned: Clean Price and Dirty Price.
Definitions
1. Accrued Interest (AI)
This is the amount of coupon interest that a bond has earned since its last coupon payment date, but has not yet been paid. It is calculated on a daily basis.
The seller is *entitled* to this interest, and the buyer *must pay it* to the seller upfront.
2. Clean Price
This is the "quoted" price of a bond. It is the price you see on a trading screen (e.g., 98.50). The clean price does not include accrued interest.
Using the clean price is the market standard because it provides a "clean" view of the bond's value based on yield, without the price appearing to jump up every day as interest accrues. It only moves when the bond's *yield* changes.
3. Dirty Price (or Full Price)
This is the actual settlement price of the bond. It is the total amount of cash that the buyer pays to the seller to complete the trade.
The formula is simple:
\[\text{Dirty Price} = \text{Clean Price} + \text{Accrued Interest}\]The Settlement Process
When you buy a bond (whether at auction or in the secondary market), here is the flow of cash:
- You and the seller agree on a Clean Price (e.g., 98.50).
- The clearinghouse calculates the Accrued Interest (e.g., 0.25).
- You (the buyer) pay the Dirty Price to the seller (e.g., $98.50 + 0.25 = 98.75$).
- You (the buyer) now hold the bond.
- On the next coupon date, you receive the full 6-month coupon.
In the end, everyone is made whole. The seller received their portion of the coupon (as Accrued Interest), and you (the buyer) received the full coupon payment but already paid the seller's portion, so you are left with only the interest you earned while you held the bond.
Worked Example: Calculating Accrued Interest
Let's calculate the accrued interest for a JGB. The formula for JGBs (which use the Actual/365 convention, explained in Section 1.9) is:
\[\text{Accrued Interest} = \frac{\text{Annual Coupon Rate} \times \text{Face Value}}{365} \times \text{Days Since Last Coupon}\]Scenario:
- Face Value: ¥1,000,000
- Annual Coupon: 1.50%
- Last Coupon Date: April 1, 2025
- Settlement Date: June 15, 2025
Step 1: Calculate the daily interest rate
\(\text{Daily Interest} = \frac{1.50\% \times ¥1,000,000}{365} = \frac{¥15,000}{365} \approx ¥41.09589\)
Step 2: Calculate the number of days
We count the *actual* number of days from (and including) the last coupon date up to (but *not* including) the settlement date.
- April: 30 days (from April 1 to 30)
- May: 31 days (from May 1 to 31)
- June: 14 days (from June 1 to 14)
- Total Days: $30 + 31 + 14 = 75$ days
Step 3: Calculate Accrued Interest
\(AI = ¥41.09589 \times 75 \text{ days} = \textbf{¥3,082}\)
(Note: In practice, calculations are done with full precision and rounded only at the end).
If the Clean Price for ¥1,000,000 face value was ¥990,000 (a quote of 99.00), the buyer would pay:
\(\text{Dirty Price} = ¥990,000 + ¥3,082 = \textbf{¥993,082}\)
Key Takeaways
- Multi-price format: Japan uses conventional (discriminatory) auctions where each winner pays their bid price
- Hybrid approach: Multi-price for coupon bonds, single-price for T-Bills
- Bid-to-cover ratio: Primary demand indicator; >3.0x is strong
- Tail is critical: Measures bid dispersion; smaller tail = stronger demand
- Clean vs dirty price: Clean is quoted, dirty is what you actually pay (clean + accrued interest)
- T+1 settlement: All auction purchases settle the next business day via BOJ-NET
References
- Japan Ministry of Finance. "Auction Calendar." Available at: https://www.mof.go.jp/english/policy/jgbs/auction/calendar/index.htm.
- Japan Ministry of Finance. "Auction Results." Available at: https://www.mof.go.jp/english/policy/jgbs/auction/index.htm.
- Bank of Japan. "Outline of JGB Auctions (Primary Market)." *Functions and Operations of the Bank of Japan*.
- Ishida, R., & Hattori, T. (2020). "Introduction to Japanese Government Bonds: Auction Systems and Academic Research." PRI Discussion Paper No. 20A-06.