Empirical Analysis of Yield Determinants in Japan’s Municipal Bond Market: Does Credit Risk Premium Exist?

In this study, we examine the determinants of the yield spread between issuers in Japan’s municipal bond market using panel data and focus on identifying whether credit risk premium exists. The results of the panel data analysis reveal new evidence on the municipal bond market for FY 2002–2013. In the first half of the 2000s, the fundamental fiscal statistics, that is, the credit risk indicators, had no impact on the yield spreads, suggesting the absence of credit risk premium. Second, Yūbari city’s insolvency in 2006 led to a structural break and since then, investors have begun accounting for local governments’ outstanding debt. Third, when important financial events occur, other credit risk indicators also significantly impact the yield spread, suggesting that during such events, investors are more aware of credit risk presence. Finally, the findings of this study provide implications for, perhaps, financial institutions, market participants, regulators.