, and policy makers. there are cases where financial markets move in line with theory, but it is not uncommon that they do not. filling in the divergence between theory and reality might lead to the formation of new theory which enables market participants'behavior to be explained rationally. in this way, financial markets have continued to develop with theory and practice stimulating each other. today, bearing this point in mind, i will attempt to provide a bridge between theory and practice, in discussing theory on financial markets and touching on the reality of the markets from the perspective of central banks. i. traditional theory on financial markets i would like to commence by talking about traditional theory on financial markets. prices in financial markets are determined as a result of a diverse range of participants trading various assets and instruments. two fundamental theories are widely shared regarding valuation and pricing in financial markets. intrinsic values first is that prices are formed in the markets based on the intrinsic economic value of assets and instruments that are traded, so they are theoretically explicable. for asset pricing, the present value of expected future cash flow of financial assets is believed to be a starting point. for example, in the stock markets, it is typically considered that " share prices are determined by the present value of the firms'future profits. " long - term interest rates formed in the bond markets are, in principle, considered to be " averages of expected future short - term rates, " and theory has been formed where term premiums are taken into account. it is believed that in the foreign exchange markets, the so - called purchasing power parity, with which " fluctuations in foreign exchange rates in the long term reflect differences in inflation rates at home and abroad, " provides a reference value. nevertheless, actual financial markets are affected by many other factors ; therefore, short - term market developments cannot be completely explained based on the theory i have just described, and even taking into account developments during a longer period, the degree of applicability and explanatory power differ. that being said, i think that the significance of the theory based on intrinsic economic values is recognized as being the foundation or the starting point of valuations and analyses of market prices. furthermore, if divergences between theoretical value and market prices continue over a long period, analyses on the cause of those divergences are thought to have important meaning in both theory and practice. efficient markets the second understanding is that prices formed in fair and transparent financial markets do not leave opportunities for

view of stronger balance sheet constraints stemming from regulations on leverage ratios and other factors, u. s. banks have become less active in interest rate arbitrage. in this situation, the interest rate on reserves at the federal reserve - - which was expected to function as the floor on the federal funds rate upon its introduction - - has changed in nature and now virtually functions as the ceiling rate, reflecting the money market structures in the united states. taking into account the actual role of the interest rate on reserves, the federal reserve has proceeded with the normalization of monetary policy by providing a new means of absorbing funds, namely reverse repos, which forms a floor on the federal funds rate. here, new practices have been created to raise interest rates with abundant liquidity in the financial system. this is an example where regulatory and structural factors exerted significant influence on the interest rate formation mechanism in the market and on central bank market operations. iv. relationship between central banks and the markets a. maintaining and improving market functioning mutual feedback between theory on financial markets and reality - - which i have elaborated on - - holds an important meaning for central banks. with regard to the more practical aspects of business at central banks, monetary policy produces effects as central banks conduct operations through which they influence prices in financial markets, and as this spreads across the markets through arbitrage. therefore, maintaining and improving market functioning is a very important issue for central banks. in relation to this point, since september 2016, the bank has implemented yield curve control, in which it sets the short - term policy interest rate at minus 0. 1 percent, and purchases jgbs so that 10 - year jgb yields remain at around 0 percent. under this framework, it can be described that market mechanisms allow the entire yield curve to be consistent with the levels of short - and long - term interest rates indicated as the operating targets in the guideline for market operations. furthermore, the bank's securities lending facility - - through which it temporarily provides japanese government securities ( jgss ) it holds depending on market conditions - - is conducted from the perspective of supporting that mechanism in the jgs markets. aiming to ensure stability and high functionality in financial markets, the bank has actively supported initiatives such as ( 1 ) the development of market conventions including in the money markets and foreign exchange markets, ( 2 ) shortening of the jgb settlement cycle, and ( 3 ) the development of a market level business continuity plan. moreover, the bank