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| Structural Modeling and Analysis of Liquidity Premium in Ultra-Long Term Yields |
| NIU Linlin, LIN Mucai
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| The Wang Yanan Institute for Studies in Economics, Xiamen University |
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Abstract Compiling the ultra-long term bond yields is critical in establishing a reasonable yield curve. Taking into account the liquidity condition of ultra-long term bonds, this paper establishes an arbitrage-free term structure model by introducing a liquidity factor that describes the yields of ultra-long term bond under the Nelson-Siegel setting. The empirical study shows that the model performs well in fitting the yield curve. Investors demand an invariant positive liquidity premium for ultra-long-term bonds, and the liquidity factor is highly correlated and consistent with traditional liquidity measures. Finally, impulse response analysis shows that there is a significant interaction between the liquidity factor and the three NS factors, and according to variance decomposition, the contribution of the liquidity factor is significant in explaining the variance of the level and slope factors.
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Received: 28 November 2016
Published: 18 January 2018
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