Abstract-2016121602


Abstract

We interpret the yield spread between government-guaranteed bonds and government bonds as market liquidity, and use this novel measure to decompose the municipal bond spread into credit and liquidity premiums in the Japanese market. Our model-free approach not only provides the term structure of the illiquidity premium, but also captures the impact of illiquidity events and the illiquidity condition of the fixed-income market. The liquidity factor plays an important role in the municipal bond spread, which suggests local governments have the opportunity to reduce their financing costs through enhancing market liquidity. The liquidity measure is provided publically for future applications.