Article ID Journal Published Year Pages File Type
973732 Pacific-Basin Finance Journal 2012 17 Pages PDF
Abstract

This paper decomposes issue spreads on US dollar-denominated bonds issued by LIBOR panel banks into credit risk and liquidity premium components. We attribute the recent increase in issue spreads to the investor perception that banks are less creditworthy than in the past. Although the behaviour of the credit risk component is well-explained by a structural model of default, this mechanism is nullified by the introduction of government guarantees. The behaviour of the liquidity premium component is partially explained by the bid/ask spread in the secondary market and issue size. Government guarantees also reduce the liquidity component of the issue spread.

► We decompose issue spreads on bonds into credit risk and liquidity components. ► The credit risk component is well-explained by a structural model of default. ► The credit risk channel is nullified by the introduction of government guarantees. ► The liquidity premium component is partially explained by bid/ask spreads and issue size. ► Government guarantees reduce the liquidity component, suggesting they enhance marketability.

Related Topics
Social Sciences and Humanities Economics, Econometrics and Finance Economics and Econometrics
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