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Joint estimation of liquidity and credit risk premia in bond prices with an application

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  • Jens H. E. Christensen
  • Daan Steenkamp

Abstract

This paper introduces a novel arbitrage-free dynamic term structure model that jointly accounts for liquidity and credit risk premia in panels of bond prices. While liquidity risk is bond-specific, credit risk is common across bonds and follows a square-root process to ensure nonnegativity and econometric identification. A simulation study confirms the separate identification of liquidity and credit risk. We apply the model to South African government bond prices and document the existence of large and weakly correlated liquidity and credit risk premia. This underscores that liquidity and credit stresses are distinct risks to bond investors.

Suggested Citation

  • Jens H. E. Christensen & Daan Steenkamp, 2025. "Joint estimation of liquidity and credit risk premia in bond prices with an application," Working Papers 11074, South African Reserve Bank.
    • Handle: RePEc:rbz:wpaper:11074
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    References listed on IDEAS

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    1. Zhiguo He & Wei Xiong, 2012. "Rollover Risk and Credit Risk," Journal of Finance, American Finance Association, vol. 67(2), pages 391-430, April.
    2. Scott Joslin & Kenneth J. Singleton & Haoxiang Zhu, 2011. "A New Perspective on Gaussian Dynamic Term Structure Models," The Review of Financial Studies, Society for Financial Studies, vol. 24(3), pages 926-970.
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    8. Beauregard, Remy & Christensen, Jens H.E. & Fischer, Eric & Zhu, Simon, 2024. "Inflation expectations and risk premia in emerging bond markets: Evidence from Mexico," Journal of International Economics, Elsevier, vol. 151(C).
    9. Andreasen, Martin M. & Christensen, Jens H.E. & Rudebusch, Glenn D., 2019. "Term Structure Analysis with Big Data: One-Step Estimation Using Bond Prices," Journal of Econometrics, Elsevier, vol. 212(1), pages 26-46.
    10. Samuel Thompson, 2008. "Identifying Term Structure Volatility from the LIBOR-Swap Curve," The Review of Financial Studies, Society for Financial Studies, vol. 21(2), pages 819-854, April.
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    Cited by:

    1. Jens H. E. Christensen & Daan Steenkamp, 2026. "A Market-Based Assessment of the Outlook for Inflation Expectations and Monetary Policy in South Africa," Working Paper Series 2026-03, Federal Reserve Bank of San Francisco.
    2. Jesus Bejarano & Rangan Gupta, 2026. "Impact of Climate Change on South Africa: Evidence from a DSGE Model," Working Papers 202601, University of Pretoria, Department of Economics.
    3. Horn, Aidan J. & Martin, Lisa & Pretorius, Jan H. & Steenkamp, Daan, 2025. "Gaps in the South African Inflation Targeting Debate," MPRA Paper 124010, University Library of Munich, Germany.

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