Aaltodoc publication archive (Aalto University institutional repository)
School of Business | Department of Finance | Finance | 2013
Thesis number: 13498
Origins of illiquidity shocks and their impact on yields in the euro area government bond market
|Title:||Origins of illiquidity shocks and their impact on yields in the euro area government bond market|
|Year:||2013 Language: eng|
|Department:||Department of Finance|
|Index terms:||rahoitus; financing; likviditeetti; liquidity; joukkovelkakirjat; bonds and debentures; valtionlainat; public loans; euro; euro; valuutta; currency|
|Key terms:||liquidity, liquidity term structure, government bond, Eurozone|
PURPOSE OF THE STUDY:
The objective of this thesis is to study the origins of illiquidity shocks and the impact of illiquidity shocks on yields in the European government bond market. Specifically, I study whether inflation, default premium and term premium shocks and volatility spikes lead to illiquidity spikes. Furthermore, I study whether the illiquidity shocks are reflected in the yields and how the impact of illiquidity shocks differs across countries and maturities. I also study how the role of liquidity and its impact on yields changes during the Eurozone crisis.
DATA AND METHODOLY:
The dataset includes benchmark government bonds with maturities 2-, 5, 7-, 10-, 15- and 30- year bonds from Austria, Belgium, France, Germany, Italy, the Netherlands, Portugal and Spain from January 1, 2003 to December 31, 2012. The time period is divided into two sub periods: from January 1, 2003 to November 30, 2009 and from December 1, 2009 to December 31, 2012. To test the hypotheses, I estimate several structural vector autoregressions (SVAR) and impulse responses to Cholesky 1% shocks.
The empirical results of this thesis show that the illiquidity drivers differ significantly in two time periods studied. Inflation shocks lead to liquidity spikes in the first period. In the second period, default and volatility shocks cause the illiquidity spikes. Changes in the steepness of the yield curve, term spread, moves the bid ask spread in both time periods although the impact is opposite. I also find that illiquidity spikes are reflected in the yields in most of the countries. In the first time period, short-term illiquidity and in the second time period the long-term illiquidity shocks are reflected in the yields across the yield curve. The impact of illiquidity shocks is the strongest on the small bond markets and markets with higher credit risk. Thirdly, I find that the illiquidity significantly deteriorates and the impact of illiquidity shocks on yields is stronger during the crisis period.
Master's theses are stored at Learning Centre in Otaniemi.