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.

 

References: 

Amihud, Y., Mendelson, H., Liquidity, Maturity, and the Yields on U.S. Treasury Securities, “The Journal of Finance”, Vol. 46, pp. 1411-1425, 1991.

Association of German Pfandbriefe Banks, The Pfandbrief 2006, Facts and Figures about Europe’s Covered Bond Benchmark, 2006.

Boss, M., Scheicher, M., The Determinants of Credit Spread Changes in the Euro Area, BIS Papers 12, pp. 181-199, 2002.

Breger, L., Stovel D., Agency Ratings in the Pfandbriefe Market, “The Journal of Portfolio Management”, Vol. 30, No. 4, 2004

Cox J. C., Ingersoll, J.E., Ross S. A., A Theory of the Term Structure of Interest Rates, “Econometrica”, Vol. 53, pp. 385-407, 1985.

Crabbe, L. E., Turner, C. M., Does the Liquidity of a Debt Issue Increase with Its Size? Evidence from the Corporate Bond and Medium-Term Note Markets, “The Journal of Finance”, Vol. 50, pp. 1719-1734, 1995.

De Jong, F., Time Series and Cross-Section Information in Affine Term-Structure Models, “Journal of Business and Economic Statistics”. Vol. 18, pp. 300-314, 2000.

Dillon, W. R. Goldstein M., Multivariate Analysis Methods and Applications, New York 1984.

Driessen, J., Is Default Event Risk Priced in Corporate Bonds?, “Review of Financial Studies”, Vol. 18, pp. 165-295, 2005.

Duffe, G. R., Estimating the Price of Default Risk, “Review of Financial Studies”, Vol. 12, pp. 197-226, 1999.

Elton, E. J., Green C., Tax and Liquidity Effects in Pricing Government Bonds, “The Journal of Finance” Vol. 53, pp. 1533-1562, 1998.

Elton, E. J., Gruber, M. J., Agrawal, D., Mann, C., Explaining the Rate Spread on Corporate Bonds, “The Journal of Finance” Vol. 56, pp. 247-277, 2001.

Feller, W., Two Singular Diffusion Problems, “Annals of Mathematics”, Vol. 54, pp. 173-182, 1951.

Fisher, L., Determinants of Risk Premiums on Corporate Bonds, “Journal of Political Economy”, Vol. 67, pp. 217-237, 1959.

Fleming, M. J., Are Larger Treasury Issues More Liquid? Evidence from Bill Reopenings, ”Journal of Money, Credit and Banking”, Vol. 3, pp. 70-735, 2002.

German Central Bank, Der Markt für deutsche Bundeswertpapiere, 3rd edition, 2000.

Goyenko, R., Subrahmanyam, A., Ukhov, A., The Term Structure of Bond Market Liquidity, working paper, McGill University, UCLA, Indiana University, 2008.

Harrison, J. M., Pliska, S. R., Martingales and Stochastic Integrals in the Theory of Continuous Trading, “Stochastic Processes and their Applications”, Vol. 11, pp. 215-260,1981.

Harvey, A. C., Forecasting Structural Time Series Models and the Kalman Filter, Cambridge, 2001.

Houweling P., Mentink, A., Vorst, T., Comparing Possible Proxies of Corporate Bond Liquidity, “Journal of Banking & Finance”, Vol. 29, pp. 1331-1358, 2005.

Jankowitsch, R., Mösenbacher, H., Pichler, S., Measuring the Liquidity Impact on EMU Government Bond Prices, “The European Journal of Finance”. Vol. 12, pp. 253-269, 2006

Kamara, A., Liquidity, Taxes, and Short-Term Treasury Yields, “Journal of Financial and Quantitative Analysis”, Vol. 29, pp. 403-416, 1994.

Kempf, A., Uhrig-Homburg, M., Liquidity and its Impact on Bond Prices, “Schmalenbach Business Review”, Vol. 52, pp. 26-44, 2000.

Koziol, C., Sauerbier, P., Valuation of Bond Illiquidity: An Option-Theoretical Approach, “The Journal of Fixed Income”, Vol. 16, pp. 81-107, 2007

Longstaff, F., The Flight-To-Liquidity Premium in U.S. Treasury Bond Prices, “Journal of Business”, Vol. 77, pp. 511-526, 2004.

Nelson, C. R., Siegel, A. F., Parsimonious Modeling of Yield Curves, “Journal of Business”, Vol. 60, pp. 473-489, 1987.

Protter, P., Stochastic Integration and Differential Equations, New York, 1990.

Sarig, O., Warga, A., Some Empirical Estimates of the Risk Structure of Interest Rates, “The Journal of Finance”, Vol. 44, pp. 1351-1360, 1989.

Vasicek, O., An Equilibrium Characterization of the Term Structure, “Journal of Financial Economics”, Vol. 5, pp. 177-188, 1977.

Warga, A., Bond Returns, Liquidity, and Missing Data, “Journal of Financial and Quantitative Analysis”, Vol. 27, pp. 605-617, 1992.

 

 

 

Download PDF

Read 1335 times Last modified on Thursday, 27 February 2014 11:04