Bond default of super-large real estate company and government debt risk

Abstract

This paper investigates risk spillover from the real estate sector to local government debt in China. Using Chinese real estate giant Evergrande's bond default as a shock and data on the issuances of urban investment bonds (UIBs), we find that super-large real estate company' default significantly increases the risk premium of UIBs, which typically represents the risk associated with local governments' implicit debts. The risk spillover is more pronounced in less developed regions, for local government financing vehicles (LGFVs) with lower credit ratings, and for debt instruments with inadequate guarantee measures. Further analysis reveals that the spillover effect is related to land asset values and triggered by two mechanisms: “land finance by local governments” and “the debt burden of LGFVs”. This study enriches our understanding of the risk interconnectedness between the real estate sector and local government debt.