40 Pages Posted: 2 Apr 2012 Last revised: 21 Feb 2014
Date Written: March 06, 2013
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: 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