38 Pages Posted: 26 Jul 2006
Date Written: July 2006
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: 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