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The term structure of bond market liquidity conditional on the economic environment: An analysis of government guaranteed bonds

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  • Schuster, Philipp
  • Uhrig-Homburg, Marliese

Abstract

We analyze the term structure of illiquidity premiums as the difference between the yield curves of two major bond segments that are both government guaranteed but differ in their liquidity. We show that its characteristics strongly depend on the economic situation. In crisis times, illiquidity premiums are higher with the largest increase for short-term maturities. Moreover, their reaction to changes in fundamentals is only significant during crises: premiums of all maturities depend on inventory risk, short maturities are highly sensitive to liquidity preferences (flight-to-liquidity). Therefore, calibrating risk management models in normal times underestimates illiquidity risk and misjudges term structure effects.

Suggested Citation

  • Schuster, Philipp & Uhrig-Homburg, Marliese, 2012. "The term structure of bond market liquidity conditional on the economic environment: An analysis of government guaranteed bonds," Working Paper Series in Economics 45, Karlsruhe Institute of Technology (KIT), Department of Economics and Business Engineering.
  • Handle: RePEc:zbw:kitwps:45
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    References listed on IDEAS

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    More about this item

    Keywords

    bond liquidity; term structure of illiquidity premiums; regime-switching; financial crisis; flight-to-liquidity;

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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