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Flight-to-Quality or Flight-to-Liquidity? Evidence From the Euro-Area Bond Market

  • Alessandro Beber
  • Michael W. Brandt
  • Kenneth A. Kavajecz

Do bond investors demand credit quality or liquidity? The answer is both, but at different times and for different reasons. Using data on the Euro-area government bond market, which features a unique negative correlation between credit quality and liquidity across countries, we show that the bulk of sovereign yield spreads is explained by differences in credit quality, though liquidity plays a non-trivial role especially for low credit risk countries and during times of heightened market uncertainty. In contrast, the destination of large flows into the bond market is determined almost exclusively by liquidity. We conclude that credit quality matters for bond valuation but that, in times of market stress, investors chase liquidity, not credit quality.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 12376.

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Date of creation: Jul 2006
Date of revision:
Publication status: published as Alessandro Beber & Michael W. Brandt & Kenneth A. Kavajecz, 2009. "Flight-to-Quality or Flight-to-Liquidity? Evidence from the Euro-Area Bond Market," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 22(3), pages 925-957, March.
Handle: RePEc:nbr:nberwo:12376
Note: AP IFM
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