Contagion Effects of Local Government Debt Risks: An Event Study Based on the Default of LGFV 's Non‐Standard Debt

Abstract

ABSTRACT In China, local governments generally mitigate the financing pressures by setting up local government financing vehicles (LGFVs), which can use standardised financing tools, such as bank loans and bonds, or employ non‐standardised financing methods. Exploiting the default events of non‐standard debt of LGFVs as natural experiments, we analyse the regional contagion effects of debt risk. We show that these defaults widen the credit spreads of non‐defaulkted LGFV bonds in secondary markets by weakening expectations of implicit government guarantees and tightening LGFVs’ financing constraints. Our findings provide new evidence on the spillover effects of default risk and highlight the economic implications of non‐standard debt defaults.