Working Paper: NBER ID: w12376
Authors: Alessandro Beber; Michael W. Brandt; Kenneth A. Kavajecz
Abstract: 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.
Keywords: bond market; credit quality; liquidity; euro area; yield spreads
JEL Codes: G0; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Market stress (G19) | Investors prioritize Liquidity over Credit quality (G33) |
| Credit quality (F34) | Yield spreads (E43) |
| Liquidity (E41) | Yield spreads (E43) |
| Market stress (G19) | Liquidity influences Yield spreads (E43) |
| Liquidity (during stress) (G33) | Yield spreads (E43) |