The pricing of local government bonds in China: A bank-government relationship perspective

Abstract

This paper investigates the pricing mechanism of local government bonds in China from the perspective of the bank-government relationship. Based on a comprehensive dataset, we find that, before the regulatory policy implemented in May 2018, bonds issued by regions more closely connected with underwriting banks in terms of local treasury cash management exhibited significantly lower spreads. However, the negative effect of the bank-government relationship on bond spreads diminished after the policy event. We validate the robustness of these findings using various econometric specifications. Mechanism analysis indicates that the regulatory policy significantly weakened the role of pre-existing bank-government relationships and encouraged greater participation of non-bank underwriters. Our estimation also rules out the channel related to the size of underwriting banks. Furthermore, we find that the aforementioned pattern is more pronounced during periods of looser market liquidity or in regions with less developed financial markets.