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A Guarantee – Does the Obligee Agree? A Risk Premium Decomposition of Sub-Sovereign Bond Spreads

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  • Knezevic, David

    (Örebro University School of Business)

  • Krüger, Niclas

    (Örebro University School of Business)

  • Nordström, Martin

    (Örebro University School of Business)

Abstract

The purpose of this paper is to investigate if credit markets believe in the existence of a central government guarantee and if this can be observed in the yield spread of the municipal sector. This is done by decomposing the municipal bond yield spread into liquidity and credit risk premiums by variance decomposition in a vector autoregressive setting – an approach which, to our knowledge, has not been previously suggested. Our results show that 62% or 50 basis points of the yield spread is explained by the chosen liquidity and credit variables. The liquidity risk premium makes up 35% or 28 basis points of the yield spread and credit makes up 27% or 22 basis points. Thus, investors and creditors in general do not believe in the existence of such a guarantee.

Suggested Citation

  • Knezevic, David & Krüger, Niclas & Nordström, Martin, 2019. "A Guarantee – Does the Obligee Agree? A Risk Premium Decomposition of Sub-Sovereign Bond Spreads," Working Papers 2019:12, Örebro University, School of Business.
    • Handle: RePEc:hhs:oruesi:2019_012
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    More about this item

    Keywords

    Municipality bonds; risk premium; credit risk; liquidity risk; yield spread;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • H74 - Public Economics - - State and Local Government; Intergovernmental Relations - - - State and Local Borrowing

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