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The Term Structure of Bond Market Liquidity Conditional on the Economic Environment: An Analysis of Government Guaranteed Bonds

40 Pages Posted: 2 Apr 2012 Last revised: 21 Feb 2014

Philipp Schuster

Karlsruhe Institute of Technology (KIT), Institute of Finance, Banking, and Insurance

Marliese Uhrig-Homburg

Karlsruhe Institute of Technology (KIT) - Institute for Finance

Date Written: March 06, 2013

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 stress: 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.

Keywords: bond liquidity, term structure of illiquidity premiums, regime-switching, financial crisis, flight-to-liquidity

JEL Classification: G01, G11, G12, G13

Suggested Citation

Schuster, Philipp and Uhrig-Homburg, Marliese, The Term Structure of Bond Market Liquidity Conditional on the Economic Environment: An Analysis of Government Guaranteed Bonds (March 06, 2013). Available at SSRN: https://ssrn.com/abstract=2033170 or http://dx.doi.org/10.2139/ssrn.2033170

Philipp Schuster (Contact Author)

Karlsruhe Institute of Technology (KIT), Institute of Finance, Banking, and Insurance ( email )

Kaiserstra├če 12
Karlsruhe, Baden W├╝rttemberg 76131
Germany
+49 721 608 48184 (Phone)
+49 721 608 48190 (Fax)

HOME PAGE: http://derivate.fbv.kit.edu

Marliese Uhrig-Homburg

Karlsruhe Institute of Technology (KIT) - Institute for Finance ( email )

P.O. Box 6980
D-76049 Karlsruhe, DE
Germany
+49 721 6084 8183 (Phone)
+49 721 6084 8190 (Fax)

HOME PAGE: http://derivate.fbv.kit.edu/english/index.php

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