A Guarantee – Does the Obligee Agree? A Risk Premium Decomposition of Sub-Sovereign Bond Spreads

David Knezevic (), Niclas Krüger () and Martin Nordström ()
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David Knezevic: Örebro University School of Business, Postal: Örebro University, School of Business, SE - 701 82 ÖREBRO, Sweden
Niclas Krüger: Örebro University School of Business, Postal: Örebro University, School of Business, SE - 701 82 ÖREBRO, Sweden, https://www.oru.se/english/employee/niclas_kruger
Martin Nordström: Örebro University School of Business, Postal: Örebro University, School of Business, SE - 701 82 ÖREBRO, Sweden

No 2019:12, Working Papers from Örebro University, School of Business

Abstract: The purpose of this paper is to investigate if credit markets believe in the existence of a central government guarantee and if this can be observed in the yield spread of the municipal sector. This is done by decomposing the municipal bond yield spread into liquidity and credit risk premiums by variance decomposition in a vector autoregressive setting – an approach which, to our knowledge, has not been previously suggested. Our results show that 62% or 50 basis points of the yield spread is explained by the chosen liquidity and credit variables. The liquidity risk premium makes up 35% or 28 basis points of the yield spread and credit makes up 27% or 22 basis points. Thus, investors and creditors in general do not believe in the existence of such a guarantee.

Keywords: Municipality bonds; risk premium; credit risk; liquidity risk; yield spread (search for similar items in EconPapers)
JEL-codes: G12 G23 H74 (search for similar items in EconPapers)
Pages: 43 pages
Date: 2019-12-20
New Economics Papers: this item is included in nep-upt
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Persistent link: https://EconPapers.repec.org/RePEc:hhs:oruesi:2019_012

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