Why is US Dollar Bond Funding for International Banks More Expensive?

40 Pages Posted: 21 Aug 2011

See all articles by Russell Poskitt

Russell Poskitt

Independent

Chris Single

affiliation not provided to SSRN

Date Written: August 20, 2011

Abstract

This paper decomposes issue spreads on USD-denominated bonds issued during the period between mid-2005 and mid-2010 into credit risk and liquidity premium components. Regression analysis shows that the behaviour of the credit risk component is well-explained by a structural model of default, consistent with prior research. However the sensitivity of the credit risk component to the structural model variables is nullified by the introduction of government guarantees. We also find that the liquidity premium component can be partially explained by the bid/ask spread in the secondary market, consistent with the liquidity premium impounding future illiquidity, and with the issue size, consistent with the price pressure hypothesis. Government guarantees reduce the liquidity component of the issue spread, consistent with the notion that government guarantees enhance the marketability of bonds during times of financial stress. We attribute the increase in long-term funding costs experienced by international banks raising funds in the US bond market to the investor perception that banks are less creditworthy than in the past.

Keywords: Bond spreads, credit risk, liquidity premium, financial crisis

JEL Classification: G01, G10, G15

Suggested Citation

Poskitt, Russell and Single, Chris, Why is US Dollar Bond Funding for International Banks More Expensive? (August 20, 2011). 24th Australasian Finance and Banking Conference 2011 Paper, Available at SSRN: https://ssrn.com/abstract=1913468 or http://dx.doi.org/10.2139/ssrn.1913468

Chris Single

affiliation not provided to SSRN

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