The flight to safety during credit recovery: The role of implicit government guarantees

Abstract

This paper examines the investor flight-to-safety phenomenon during the credit recovery period following corporate bond defaults. We find that implicit government guarantee (IGG) bonds crowd out non-implicit government guarantee (non-IGG) bonds in the Chinese corporate bond market at the provincial level. The crowding-out effect is stronger in a province with scarce bank credit resources. In contrast, the crowding-out effect disappears when the bonds are explicitly guaranteed by a third-party or if the default event is triggered by a state-owned enterprise (SOE). This finding is robust to various maturity terms, alternative samples, propensity score matching and placebo tests. Our evidence highlights the significant role of implicit government guarantees in the crowding-out effect during the credit recovery period.