What Drives Liquidity in the Chinese Credit Bond Markets?

Abstract

This paper documents the pricing of liquidity and identifies its drivers in the four main segments of the interbank and exchange credit bond markets in China. First, we find that liquidity effects are priced in credit bond yield spreads, and differ significantly across these four segments. Second, we identify several channels through which liquidity may affect the pricing of credit bonds. We find that the risk-sharing channel and the macroeconomic channel have significantly influenced liquidity effects, while the information channel does not seem to have had any such clear impact. Third, we analyze the impact of two types of policy shocks, including one collateral shock on repo-eligibility in the exchange market and four liberalization shocks on foreign investment in the interbank market, on the levels of liquidity and the pricing of liquidity effects in the Chinese credit bond markets. We identify the most important of the four policy shocks on interbank liberalization to be the policy on the Bond Connect program linking Chinese and overseas markets.

Keywords: credit bonds; yield spread; liquidity effects; policy shocks; China

JEL Classification: G12, G15, G18