Rigid payment breaking, default spread and yields of Chinese treasury bonds

While the existence of implicit payment guarantees has long characterized Chinese bond market, recent market oriented reforms in the country have gradually broken this regime. In this context, we examine how the breaking of rigid payment regime influences the yields of Chinese treasury bonds. We argue that the rigid payment breaking affects the yields of treasury bonds by influencing investors’ setup of default risk premiums and the demand for “flight-to-quality” and “flight-to-liquidity”. Our analysis of the daily data of Chinese treasury bond transactions over the period of 2009–2019 support our theoretical arguments, indicating that rigid payment breaking has a negative impact on the yields of Chinese treasury bonds. However, this impact is heterogeneous across the bonds with different maturities and the significant effect exists only for medium and long-term treasury bonds. Our findings advance understanding of how the breaking of rigid payment regime influences the yields of financial products, providing guidelines for how investors should optimize their investment portfolios in the bond market.