The Impact of Government Intervention on Municipal Bond Liquidity Premium: Evidence from China

Abstract

Government intervention is an important factor which restricts the development of municipal bond market in China. Based on the revenue bond innovation pilot policy implemented by the Ministry of Finance in 2017, this paper uses municipal bond trading data of Chinese inter-bank bond market from May 2017 to June 2018 and the two-stage least squares method to study the impact of government intervention on the liquidity premium of municipal bonds. The results of the empirical research show: (1) The liquidity risk of municipal bonds is a factor that affects the yield spread, and the marginal impact of liquidity risk on the yield spread is about 4.6 basis points. (2) After the implementation of the revenue bond innovation pilot policy, the reduction of local government intervention significantly reduced the liquidity premium level of municipal bonds. Based on the above conclusions, we propose policy recommendations for the development of the municipal bond market in the short and long term.