Liquidity effects in the german bond market: findings from the jumbo pfandbriefe segment

Liquidity effects in the german bond market: findings from the jumbo pfandbriefe segment


Daniel Lange


Keywords: Term structure, Liquidity risk, Bond market, Germany, Principal Components Analysis (PCA), Affine model, Kalman filter


Summary: The purpose of this article is to investigate liquidity effects in the German bond market. Using data on Jumbo Pfandbriefe and German government bonds, the author derives an accurate estimate of the term structure of liquidity spreads in the period January 1999 to October 2008. On average, long maturity bonds exhibit a higher liquidity premium than short maturity bonds. In times of crisis, however, the term structure can invert. A principal components analysis shows that 78.70 % of the total variation in liquidity spread changes can be explained by a single component and augmented Dickey-Fuller tests reject the hypothesis of a unit root for liquidity spread changes in all maturity classes under examination. Therefore, an affine one-factor model of the term structure of liquidity spread changes is presented and a factor time series is extracted by the use of a Kalman filter in combination with Maximum Likelihood estimation of the model parameters. Subsequently, the models’ empirical performance is analysed using differences between real and model spread changes as well as one-step-ahead prediction errors generated by the Kalman filter. On average the model provides an adequate fit of the term structure of liquidity spreads for medium term maturities.



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