Spanish Treasury Bond Market Liquidity Pre- and Post-European Monetary Union

Abstract

This paper examines liquidity in the Spanish Treasury bond market in the context of debt policy shifts engineered by the Spanish government in preparation for entrance into European Monetary Union. Empirically detectable impacts of Spain's mid-1997 debt management initiatives exist for both trading activity and debt market valuation. We interpret these impacts through shifts in the coefficients of a liquidity life cycle model relating individual Treasury bond market share to a bond's age (the time since its initial auction). Tests for shifts in this market share function as a result of the Treasury's debt policy innovations clearly reject the hypothesis of no structural change in the post-initiatives sample period. We also estimate the structure of liquidity premiums in the different maturity sectors within the Spanish bond market. We investigate liquidity effects within a framework that values the flow of liquidity services generated over a bond's entire life. Lifetime liquidity involves not only a security's current of liquidity, but also the expected future amount of liquidity. Our empirical results for 10-year Spanish treasury bonds reveal statistically significant valuation impacts of expected future liquidity on current market value. The measures developed here add significant explanatory power to the traditional auction status dummy variable approaches to assessing bond liquidity value.

Keywords: Bonds, Liquidity, Spanish Public Debt, European Monetary Union

JEL Classification: G12, G15