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How Does Liquidity Affect Government Bond Yields?∗
| Content Provider | Semantic Scholar |
|---|---|
| Author | Favero, Carlo Pagano, Marco Thadden, Ernst-Ludwig Von |
| Copyright Year | 2007 |
| Abstract | The paper explores the determinants of yield differentials between sovereign bonds in the Euro area. There is a common trend in yield differentials, which is correlated with a measure of aggregate risk. In contrast, liquidity differentials display sizeable heterogeneity and no common factor. We propose a simple model with endogenous liquidity demand, where a bond's liquidity premium depends both on its transaction cost and on investment opportunities. The model predicts that yield differentials should increase in both liquidity and risk, with an interaction term of the opposite sign. Testing these predictions on daily data, we find that the aggregate risk factor is consistently priced, liquidity differentials are priced for a subset of countries, and their interaction with the risk factor is in line with the model's prediction and crucial to detect their effect. JEL classification numbers: E43, G12. ∗We gratefully acknowledge the comments of Stefan Gerlach, Eugene Kandel, Philippe Martin, Henri Pages, Eli Remolona, Raman Uppal and seminar participants at Bocconi University, the Banque de France, CEMFI (Madrid), the Bundebank and the ECB-CFS Research Network on “Capital Markets and Financial Integration in Europe”. We are grateful to the Fondation Banque de France for providing most of the funding for this project, and to Inquire for additional financial support. Euro MTS, and in particular its CEO Gianluca Garbi, have kindly supplied data and useful comments. Stephan Maier and Michele Galietta provided able research assistance. †Università Bocconi, IGIER and CEPR. ‡Università di Napoli Federico II, CSEF and CEPR. §Universität Mannheim and CEPR. |
| File Format | PDF HTM / HTML |
| DOI | 10.2139/ssrn.1284646 |
| Alternate Webpage(s) | http://www2.wiwi.hu-berlin.de/institute/wpol/schumpeter/seminar/pdf/ernstludwig.pdf |
| Alternate Webpage(s) | http://www.csef.it/pagano/JFQA-2010.pdf |
| Alternate Webpage(s) | http://vonthadden.vwl.uni-mannheim.de/fileadmin/user_upload/thadden/research/FavPagavT.pdf |
| Alternate Webpage(s) | http://www.csef.it/WP/wp181.pdf |
| Alternate Webpage(s) | http://didattica.unibocconi.it/mypage/upload/48917_20081006_044930_DRAFTDEC07_FINAL.PDF |
| Alternate Webpage(s) | http://www.cermes.unibocconi.it/wps/allegatiCTP/JFQA_fin.pdf |
| Alternate Webpage(s) | https://doi.org/10.2139/ssrn.1284646 |
| Language | English |
| Access Restriction | Open |
| Content Type | Text |
| Resource Type | Article |
