Bond yield and credit rating: evidence of Chinese local government financing vehicles

Excessive borrowing of local governments in China sparked concerns that the debt may threaten the financial stability of the economy and ultimately cause economic collapse. It becomes critically important to understand the credit rating of China’s local government financing vehicle (LGFV) bonds and the association between the yields, credit ratings, and bond characteristics under this circumstance. We use a complete pooled data set of 771 LGFV bond issues from 1999 to 2011 and OLS and two-stage-least-squares regressions to examine how credit ratings might affect LGFV bond yields and an ordered probit model to study the determinants of credit ratings. The main findings are: (1) bond characteristic variables, such as duration and guarantee, matter in determining yields though credit rating plays a major role in determining yields of LGFV bond issues; (2) bond issue size and bond type are the main determinants of LGFV bond credit ratings, while the bond issuer characteristics have little explanatory power; (3) at least in Eastern China, smaller credit rating agency tend to give better ratings after controlling for bond issuer and issue characteristics.