Flight-to-Quality or Flight-to-Liquidity? Evidence from the Euro-Area Bond Market

38 Pages Posted: 26 Jul 2006 Last revised: 27 Oct 2022

See all articles by Alessandro Beber

Alessandro Beber

Cass Business School; Centre for Economic Policy Research (CEPR)

Michael W. Brandt

Duke University - Fuqua School of Business; National Bureau of Economic Research (NBER)

Kenneth A. Kavajecz

Edgewood College; Phoenix Rising Advisory

Multiple version iconThere are 3 versions of this paper

Date Written: July 2006

Abstract

Do bond investors demand credit quality or liquidity? The answer is both, but at different times and for different reasons. Using data on the Euro-area government bond market, which features a unique negative correlation between credit quality and liquidity across countries, we show that the bulk of sovereign yield spreads is explained by differences in credit quality, though liquidity plays a non-trivial role especially for low credit risk countries and during times of heightened market uncertainty. In contrast, the destination of large flows into the bond market is determined almost exclusively by liquidity. We conclude that credit quality matters for bond valuation but that, in times of market stress, investors chase liquidity, not credit quality.

Suggested Citation

Beber, Alessandro and Brandt, Michael W. and Kavajecz, Kenneth A., Flight-to-Quality or Flight-to-Liquidity? Evidence from the Euro-Area Bond Market (July 2006). NBER Working Paper No. w12376, Available at SSRN: https://ssrn.com/abstract=918974

Alessandro Beber

Cass Business School ( email )

London, EC2Y 8HB
Great Britain

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Michael W. Brandt (Contact Author)

Duke University - Fuqua School of Business ( email )

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Durham, NC 27708-0120
United States

National Bureau of Economic Research (NBER)

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Kenneth A. Kavajecz

Edgewood College ( email )

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Phoenix Rising Advisory ( email )

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