Decomposing Municipal Bond Defaults and Liquidity Risk in Japan

This is the first paper that decomposes the municipal bond spread into its default and liquidity risk components in Japan's market. The tax effect is identified using institutional information about Japan, which enables us to simplify the model drastically. To overcome the availability of the liquidity data, we use the data of Japanese government guaranteed bonds and credit default swaps for the decomposition. Our results show that the liquidity premium was approximately 70% of the share of the municipal spread including the period of Yūbari crisis