Abstract

Bond yield spreads are affected by several factors like credit risk, liquidity risk, and taxes. Usually, these spread components are difficult to disentangle empirically. In the U.S. Government bond market, however, the regular issuing policy of the U.S. Treasury allows us to isolate a term structure of liquidity premia by exactly matching the observed yields of Treasury STRIPS and the theoretical yields obtained via bootstrapping Treasury notes. Studying the yield differences between coupon STRIPS and Treasury notes, we detect a surprisingly stable sign change between short and long maturities. We control for on-the-run effects and show that a differential taxation cannot explain the observed differences. Our approach also provides an explanation for the empirical puzzle that different STRIPS with exactly the same cash flows trade at different yields. Moreover, we show that the obtained liquidity premia significantly increase during the recent financial crisis and we trace them back to a flight-to-liquidity behavior. JEL classification:

Citations