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Assessing the liquidity premium in the Italian bond market

Author

Listed:
  • Maria Ludovica Drudi

    (Bank of Italy)

  • Giulio Carlo Venturi

    (Imperial College)

Abstract

This paper studies the effects of time-varying liquidity in the market for Italian government bonds and proposes a new methodology to estimate the liquidity premium implicit in bond prices. After adjusting for different maturities and coupon rates, we compute a yield spread between on- and off-the-run ten-year BTPs and regress this quantity on seven well-established liquidity metrics, explicitly distinguishing between current and future liquidity. We find that higher liquidity is indeed reflected in higher prices. Based on these results, we obtain a novel estimate of the liquidity premium, according to which the liquidity deterioration that occurred during the sovereign debt crisis lasted longer, but was of a smaller magnitude than that recorded during the Covid-19 pandemic.

Suggested Citation

  • Maria Ludovica Drudi & Giulio Carlo Venturi, 2023. "Assessing the liquidity premium in the Italian bond market," Questioni di Economia e Finanza (Occasional Papers) 795, Bank of Italy, Economic Research and International Relations Area.
    • Handle: RePEc:bdi:opques:qef_795_23
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    More about this item

    Keywords

    liquidity; sovereign bonds; liquidity risk; market microstructure;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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