Credit risk and bond pricing of local government in China

IMPACT Our research on local government bond pricing benefits China's central government, local governments and investors. We urge the central government to strengthen its regulation of directional bonds and special bonds, and then promote marketization. Local governments should reduce the size of directional bonds, and decouple special bonds from government financial guarantees. Investors should purchase the local government bonds which have the highest premium with equal risk. The relationship between credit risk and the pricing of local government bonds in China is explored in this paper. The pricing of local government bonds was found to reflect credit risk, but the risk premium was small. The type of bond ('directional' or 'non-directional') significantly affected pricing. Repayment source had no effect. The authors make recommendations for the central government, local governments and investors.