Is China's bond market really inefficient?

Abstract

China controls its exchange and interest rates, and does not offer RMB interest rate derivatives in China. As China is an emerging market, people expect a certain level of inefficiencies in its bond market. This can be illustrated in the way that some bonds are transacted at prices that appear to bear little relation to their fair values. However, closer inspection reveals that this is not due to market inefficiency per se, but rather the fact that bond traders in China may buy and sell bonds in bundled form. As an example, a trader may seek to hide his losses on one bond by selling it at an inflated price at the same time as buying another bond, also at an inflated price; thus, while the bonds may, individually, deviate from their fair price, bundled together, the aggregate price is fair. This is only possible for over-the-counter bond transactions, due to the opaque nature of the trade process; all bonds traded on the exchanges are transacted at their fair values.