Sovereign Credit Quality and Violations of the Law of One Price*

Asset pricing and the bid-ask spread

Jacob Boudoukh, Jordan Brooks, Matthew Richardson and Zhikai Xu

Review of Finance, 2021, vol. 25, issue 5, 1581-1607

Abstract: It is well-documented that government bonds with almost identical cash flows can trade at different prices. This article analyzes the cross-section of bond spreads across developed European countries and documents a novel result. While a measure of the convenience yield of government bonds helps explain these spreads, it cannot explain the behavior of bond spreads in periods of widening credit risk. The article documents bond spreads between new and old issues tighten for low-quality sovereigns. In other words, the newer more liquid bonds become cheaper, not more expensive, relative to their older counterparts. We offer an explanation based on price pressure and provide empirical support using data on net flows of investors in sovereign bonds.

Keywords: Liquidity; Sovereign Bonds; bond Spread; Price Pressure; Convenience yield; European Crisis; Flows (search for similar items in EconPapers)
JEL-codes: G01 G12 G14 G15 (search for similar items in EconPapers)
Date: 2021
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Citations: View citations in EconPapers (2)

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