The dual effect of upper-level government implicit guarantees on subordinate municipal corporate bond credit risk: An empirical analysis

Abstract

This paper investigates the impact of upper-level government implicit guarantees on the credit risk of city-level municipal corporate bonds in China by analyzing the dual effect of guarantee capability and willingness on municipal corporate bonds credit spread. The results indicate that the implicit guarantee capability and willingness significantly reduce credit spreads, with the latter exerting a more pronounced effect. Furthermore, regional economic development moderates the effects. In less-developed regions, the influence of implicit guarantees on bond pricing is more substantial due to heightened investor reliance on upper-level government support. The study incorporates the 2020 “Yongmei” default event as an exogenous shock to examine changes in market expectations. The findings reveal that after this event, upper-level government implicit guarantees' effect on municipal corporate bond pricing weakened, underscoring the evolving nature of investor confidence. This study advances the literature by highlighting the role of upper-level governments in municipal corporate bond pricing mechanisms and offering insights into the interplay between implicit guarantees, regional economic conditions, and investor expectations in the Chinese municipal corporate bond market.