Assessing the liquidity premium in the Italian bond market

Maria Ludovica Drudi and Giulio Carlo Venturi ()
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Giulio Carlo Venturi: Imperial College

No 795, Questioni di Economia e Finanza (Occasional Papers) from Bank of Italy, Economic Research and International Relations Area

Abstract: This paper studies the effects of time-varying liquidity in the market for Italian government bonds and proposes a new methodology to estimate the liquidity premium implicit in bond prices. After adjusting for different maturities and coupon rates, we compute a yield spread between on- and off-the-run ten-year BTPs and regress this quantity on seven well-established liquidity metrics, explicitly distinguishing between current and future liquidity. We find that higher liquidity is indeed reflected in higher prices. Based on these results, we obtain a novel estimate of the liquidity premium, according to which the liquidity deterioration that occurred during the sovereign debt crisis lasted longer, but was of a smaller magnitude than that recorded during the Covid-19 pandemic.

Keywords: liquidity; sovereign bonds; liquidity risk; market microstructure (search for similar items in EconPapers)
JEL-codes: G12 G14 (search for similar items in EconPapers)
Date: 2023-09
New Economics Papers: this item is included in nep-eec and nep-mst
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Persistent link: https://EconPapers.repec.org/RePEc:bdi:opques:qef_795_23

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