A Measure of Liquidity Risk in a Sovereign Debt Market

20 Pages Posted: 16 Sep 2011

See all articles by Emma Berenguer

Emma Berenguer

Universidad Pablo de Olavide

Ricardo Gimeno

Banco de España

Juan Miguel Nave

University of Castilla-La Mancha; Universidad CEU Cardenal Herrera

Date Written: September 16, 2011

Abstract

Since the seminal paper of Vasicek and Fong (1982) term structure models are estimated assuming that yields are cross-sectionally homokedastic. In this paper, we show that this hypothesis does not hold even for bonds from the same issuer when there are differences in their level of liquidity. Those bonds with a lower daily turnover would experiment a higher volatility around the expected yield determined by the term structure. The existence of a minimum tick size on the bond price negotiation would also produce a higher volatility for those bonds approaching their expiration term. In order to show these effects, we use data from Spanish sovereign bonds from 1988 to 2010, covering more than 700 bonds and 5000 days. With these data we have estimated the out-of-sample error for each bond and day. The variance of these errors is negatively correlated with the turnover of each bond and its duration, while the mean of the error is directly correlated with the estimated variance. Taking into account these features we propose, for fitting the term structure, a modified Svensson (1994) yield curve model where an additional liquidity term is added and parameters are estimated by weighted least squared errors to take into account the liquidity-induced heterokedasticity.

Keywords: liquidity risk, liquidity premium, yield curve, Spanish Sovereign Bonds

JEL Classification: G12, C58, E43

Suggested Citation

Berenguer, Emma and Gimeno, Ricardo and Nave, Juan Miguel, A Measure of Liquidity Risk in a Sovereign Debt Market (September 16, 2011). Available at SSRN: https://ssrn.com/abstract=1928393 or http://dx.doi.org/10.2139/ssrn.1928393

Emma Berenguer (Contact Author)

Universidad Pablo de Olavide ( email )

Ctra. Utrera, Km.1
Sevilla, Seville 41010
Spain

Ricardo Gimeno

Banco de España ( email )

Madrid 28014
Spain

Juan Miguel Nave

University of Castilla-La Mancha ( email )

Plaza Universidad, 1
02071 Albacete, Ciudad Real 13071
Spain

Universidad CEU Cardenal Herrera

Comissari, 1
Elche, Alicante
Spain

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