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Liquidity and credit risk premia in government bond yields

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  • Ejsing, Jacob
  • Grothe, Magdalena
  • Grothe, Oliver
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    Abstract

    This paper quantifies liquidity and credit premia in German and French government bond yields. For this purpose, we estimate term structures of government-guaranteed agency bonds and exploit the fact that any difference in their yields vis-`a-vis government bonds can be attributed to differences in liquidity premia. Adding the information on risk-free rates, we obtain model-free and model-based gauges of sovereign credit premia, which are an important alternative to the information based on CDS markets. The results allow us to quantify the price impact of so-called “safe haven flows”, which strongly affected bond markets in late 2008/early 2009 and again during some phases of the sovereign debt crisis. Thus, we show to what extent these effects disguised the increase of sovereign credit premia in the government yields of core euro area countries. JEL Classification: E44, G12, G01

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    Bibliographic Info

    Paper provided by European Central Bank in its series Working Paper Series with number 1440.

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    Date of creation: Jun 2012
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    Handle: RePEc:ecb:ecbwps:20121440

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    Related research

    Keywords: bond markets; Liquidity premium; sovereign credit risk; state space models; yield curve modeling;

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    References

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    1. Michael J. Fleming, 2003. "Measuring treasury market liquidity," Economic Policy Review, Federal Reserve Bank of New York, issue Sep, pages 83-108.
    2. Jan Ericsson & Olivier Renault, 2006. "Liquidity and Credit Risk," Journal of Finance, American Finance Association, vol. 61(5), pages 2219-2250, October.
    3. Long Chen & David A. Lesmond & Jason Wei, 2007. "Corporate Yield Spreads and Bond Liquidity," Journal of Finance, American Finance Association, vol. 62(1), pages 119-149, 02.
    4. Bolder, David & Streliski, David, 1999. "Yield Curve Modelling at the Bank of Canada," Technical Reports 84, Bank of Canada.
    5. Ejsing, Jacob & Lemke, Wolfgang, 2011. "The Janus-headed salvation: Sovereign and bank credit risk premia during 2008-2009," Economics Letters, Elsevier, vol. 110(1), pages 28-31, January.
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    Cited by:
    1. Grothe, Magdalena, 2013. "Market pricing of credit rating signals," Working Paper Series 1623, European Central Bank.

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