Dynamic Sources of Sovereign Bond Market Liquidity

Kucuk, Ugur N. (2010): Dynamic Sources of Sovereign Bond Market Liquidity.

Abstract

Using 482 US Dollar and Euro denominated bonds issued by 72 sovereigns, we examine the dynamic sources of time-series and cross-sectional variations in \textit{market-wide liquidity} of sovereign bonds as a novelty in the sovereign fixed income literature. Vector autoregression analysis shows that macroeconomic fundamentals and the financial market variables play a substantial role in the movements of aggregate liquidity throughout the whole sample period (1999-2010), although their effects are stronger during the financial crisis. Specifically, US industrial production growth rate and inflation rate have significant informative powers on the sovereign bond market liquidity. An increasing shock to the TED spread (the spread between 3-Month Libor and US T-bill), a measure of distrust in the banking system, has detrimental impact, while equity market performance is positively linked to market-wide bond liquidity. Furthermore, the direction of causality from the world financial and macroeconomic variables towards the aggregate bond market liquidity is confirmed by Granger causality tests. Finally, impulse response functions show that these relationships are persistent up to one-year forecast horizon.

• Item Type: MPRA Paper
• Language: English
• Keywords: Sovereign Bond Market, Aggregate Market-wide Liquidity, Financial Markets
• Subjects: G - Financial Economics > G1 - General Financial Markets > G15 - International Financial Markets; E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E44 - Financial Markets and the Macroeconomy; E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E40 - General; G - Financial Economics > G1 - General Financial Markets > G10 - General

References

Acharya, Viral V., and Lasse Heje Pedersen, 2005, Asset pricing with liquidity risk, Journal of Financial Economics 77, 375-410.

Amihud, Yakov, 2002, Illiquidity and stock returns: cross-section and time-series e_ects, Journal of Financial Markets 5, 31 - 56.

Amihud, Yakov, and Haim Mendelson, 1986, Asset pricing and the bid-ask spread, Journal of Financial Economics 17, 223-249.

Amihud, Yakov, 1989, The e_ects of beta, bid-ask spread, residual risk, and size on stock returns, The Journal of Finance 44, 479-486.

Amihud, Yakov, 1991, Liquidity, maturity, and the yields on u.s. treasury securities, The Journal of Finance 46, 1411-1425.

Beber, Alessandro, Michael W. Brandt, and Kenneth A. Kavajecz, 2006, Flight-to-quality or ight- to-liquidity? evidence from the euro-area bond market, Working Paper 12376 National Bureau of Economic Research.

Bekaert, Geert, Campbell Harvey, and Christian T. Lundblad, 2006, Liquidity and expected returns: Lessons from emerging markets, CEPR Discussion Papers 5946 C.E.P.R. Discussion Papers.

Benston, George J., and Robert L. Hagerman, 1974, Determinants of bid-asked spreads in the over-the-counter market, Journal of Financial Economics 1, 353 - 364.

Bernanke, Ben S., and Alan S. Blinder, 1992, The federal funds rate and the channels of monetary transmission, The American Economic Review 82, 901-921.

Brennan, Michael J., and Avanidhar Subrahmanyam, 1996, Market microstructure and asset pricing: On the compensation for illiquidity in stock returns, Journal of Financial Economics 41, 441 - 464.

Bulow, Jeremy, and Kenneth Rogo_, 1989, Sovereign debt: Is to forgive to forget?, American Economic Review 79, 43-50.

Caballero, Ricardo J., Emmanuel Farhi, and Pierre-Olivier, 2008, Financial crash, commodity prices and global imbalances, NBER Working Paper.

Campa, Jose, and Nuno Fernandes, 2006, Sources of gains from international portfolio diversi_ca- tion, Journal of Empirical Finance 13, 417-443.

Chen, Long, David A. Lesmond, and Jason Wei, 2007, Corporate yield spreads and bond liquidity, Journal of Finance 62, 119-149.

Chordia, Tarun, 2005, An empirical analysis of stock and bond market liquidity, Review of Financial Studies 18, 85-129.

Chordia, Tarun, Richard Roll, and Avanidhar Subrahmanyam, 2000, Commonality in liquidity, Journal of Financial Economics 56, 3 - 28.

Chordia, Tarun, 2001, Market liquidity and trading activity, The Journal of Finance 56, 501-530.

Claessens, Stijn, Daniela Klingebiel, and Sergio Schmukler, 2003, Government bonds in domestic and foreign currency: The role of macroeconomic and institutional factors, CEPR Discussion Paper No. 3789.

Cochrane, John H., and Monika Piazzesi, 2005, Bond risk premia, American Economic Review 98, 138-160.

Collin-Dufresne, P., R. Goldstein, and S. Martin, 2001, The determinants of credit spread changes, Journal of Finance 56, 21772207.

Duffie, Darrell, 1999, Credit swap valuation, Financial Analysts Journal January February, 73-87.

Duffie, Darrell, Pedersen Lasse H., and Kenneth J. Singleton, 2003, Modeling sovereign yield spreads: A case study of russian debt, Journal of Finance 58, 119-159.

Duffie, Darrell, Lasse Heje Pedersen, and Kenneth J. Singleton, 2003, Modeling sovereign yield spreads: A case study of russian debt, The Journal of Finance 58, 119-159.

Erb, Claude B, Campbell R. Harvey, and Tadas E. Viskanta, 1996, The inuence of political, economic, and _nancial risk on expected _xed-income returns, Journal of Fixed Income pp. 7-31.

Fama, Eugene F., and Kenneth R. French, 1993, Common risk factors in the returns on stocks and bonds, Journal of Financial Economics 33, 3-56.

Ferrucci, Gianluigi, 2003, Empirical Determinants of Emerging Market Economies' Sovereign Bond Spreads, SSRN eLibrary.

Fujimoto, Akiko, 2004, Macroeconomic sources of systematic liquidity, Working Paper.

Gmez-Puig, Marta, 2006, Size matters for liquidity: Evidence from emu sovereign yield spreads, Economics Letters 90, 156 - 162.

Goetzmann, William, Lingfeng Li, and Geert Rouwenhorst, 2005, Long-term global market corre- lations, Journal of Business 78, 1-31.

Goodhart, Charles A. E., and Maureen O'Hara, 1997, High frequency data in financial markets: Issues and applications, Journal of Empirical Finance 4, 73-114.

Goyenko, Ruslan Y., and Andrey D. Ukhov, 2009, Stock and bond market liquidity: A long-run empirical analysis, Journal of Financial and Quantitative Analysis 44, 189-212.

Harvey, Campbell R., and Roger D. Huang, 2001, The Impact of the Federal Reserve Bank's Open Market Operations, SSRN eLibrary.

Houweling, Patrick, Albert Mentink, and Ton Vorst, 2003, How to measure corporate bond liquid- ity?, Tinbergen Institute Discussion Papers 03-030/2 Tinbergen Institute.

Huang, J., and M. Huang, 2003, How much of the corporate-treasury yield spread is due to credit risk, Working paper, Stanford University.

Kamara, Avraham, 1994, Liquidity, taxes, and short-term treasury yields, The Journal of Financial and Quantitative Analysis 29, 403-417.

Kucuk, Ugur N., 2010, Non-default component of sovereign emerging market yield spreads and its determinants: Evidence from credit default swap market, The Journal of Fixed Income Spring 2010, Vol. 19, 44-66.

Longstaff, Francis A., 2004, The ight to liquidity premium in u.s. treasury bond prices, Journal of Business 77, 51526.

Longstaff, Francis A.,, Sanjay Mithal, and Eric Neis, 2005, Corporate yield spreads: Default risk or liquidity? new evidence from the credit default swap market, Journal of Finance 60, 2213-2253.

Longstaff, Francis A., Jun Pan, Pedersen, Lasse H., and Kenneth J. Singleton, 2008, How soverign is sovereign credit risk?, NBER Working Paper 13658.

Pastor, L'ubos, and Robert F. Stambaugh, 2003, Liquidity risk and expected stock returns, Journal of Political Economy 111, 642-685.

Rozada, Martin, and Eduardo Yeyati, 2005, Global factors and emerging market spreads, Working paper, Universidad Torcuato Di Tella.

Solnik, Bruno, 1974, 1974, Why not diversify internationally rather than domestically?, Financial Analysts Journal 30, 48-54.

Thorbecke, Willem, 1997, On stock market returns and monetary policy, The Journal of Finance 52, 635-654.

Tirole, Jean, 2002, Financial Crises, Liquidity, and the International Monetary System (Princeton University Press: Princeton, New Jersey).

Warga, Arthur, 1992, Bond returns, liquidity, and missing data, The Journal of Financial and Quantitative Analysis 27, 605-617.

White, Halbert, 1980, A heteroskedasticity-consistent covariance matrix estimator and a direct test for heteroskedasticity, Econometrica 48, 817-838.