Flight-to-Quality or Flight-to-Liquidity? Evidence from the Euro-Area Bond Market

38 Pages Posted: 26 Jul 2006  

Alessandro Beber

Cass Business School; Centre for Economic Policy Research (CEPR)

Michael W. Brandt

Duke University - Fuqua School of Business; National Bureau of Economic Research (NBER)

Kenneth A. Kavajecz

Syracuse University - Whitman School; University of Wisconsin, Madison - Department of Finance, Investment and Banking

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Date Written: July 2006

Abstract

Do bond investors demand credit quality or liquidity? The answer is both, but at different times and for different reasons. Using data on the Euro-area government bond market, which features a unique negative correlation between credit quality and liquidity across countries, we show that the bulk of sovereign yield spreads is explained by differences in credit quality, though liquidity plays a non-trivial role especially for low credit risk countries and during times of heightened market uncertainty. In contrast, the destination of large flows into the bond market is determined almost exclusively by liquidity. We conclude that credit quality matters for bond valuation but that, in times of market stress, investors chase liquidity, not credit quality.

Suggested Citation

Beber, Alessandro and Brandt, Michael W. and Kavajecz, Kenneth A., Flight-to-Quality or Flight-to-Liquidity? Evidence from the Euro-Area Bond Market (July 2006). NBER Working Paper No. w12376. Available at SSRN: https://ssrn.com/abstract=918974

Alessandro Beber

Cass Business School ( email )

London, EC2Y 8HB
Great Britain

Centre for Economic Policy Research (CEPR) ( email )

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

Michael W. Brandt (Contact Author)

Duke University - Fuqua School of Business ( email )

1 Towerview Drive
Durham, NC 27708-0120
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Kenneth A. Kavajecz

Syracuse University - Whitman School ( email )

900 S. Crouse Avenue
Syracuse, NY 13244-2130
United States

University of Wisconsin, Madison - Department of Finance, Investment and Banking ( email )

975 University Avenue
Madison, WI 53706
United States

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