Abstract
This paper examines the determinants of the dynamic connectedness between sovereign bond yields in a sample of G7 countries. In addition to the common macroeconomic factors, we focus on the impact of Economic Policy Uncertainty (EPU) on the dynamic connectedness patterns between bond yields. To this end, we first examine the full-sample connectedness among the seven bond yields and examine various features of connectedness using a measure recently proposed by Diebold and Yilmaz (Int J Forecast 28(1):57-66, 2012). To examine the determinants of the dynamic connectedness, we use the panel data model to consider the dynamic net connectedness between the considered bond yields as the endogenous variable. Overall, being the transmitter or recipient of spillovers appears to have independent and different influences depending on each of the two types of sovereign bond yields. Also, the findings support the idea that EPU can create an environment likely to exacerbate the transmission of spillover shocks between two-year sovereign bond yields. Conversely, on the whole, EPU does not appear to affect the connectedness of thirty-year sovereign bond yields in various bond markets. The findings also reveal the significant impacts of real output on how shocks across countries manifest in different ways.
Highlights
There has been growing interest in analysing spillover and dynamic connectedness across international financial markets, especially after the emergence of the US subprime mortgage and European sovereign debt crises (Meegan et al 2018; Kim et al 2015; Jung and Maderitsch 2014)
In addition to attempting to measure the degree of connectedness and their sensitivity to time horizons, this paper examines how macroeconomic factors such inflation rates, the real interest rate and the economic growth influence the dynamic of net connectedness among the considered sovereign bond yields
Before the GFC, we find that Italy and France’s sovereign bond markets were the net transmitters of volatility spillovers shock to other markets, implying that these markets are the foremost drivers of the bond market volatility of other G7 countries
Summary
There has been growing interest in analysing spillover and dynamic connectedness across international financial markets, especially after the emergence of the US subprime mortgage and European sovereign debt crises (Meegan et al 2018; Kim et al 2015; Jung and Maderitsch 2014). Prior studies that have identified shocks transmission between bond markets, which generally focus on the effects of the benchmark term structure of interest rates on bond risk premia, spread the first moment and assume a non-informational interaction between sovereign bond volatilities (Cepni et al 2019; Presbitero et al 2016a) Another branch of literature has relied exclusively on isolated studies of target counties and regions or a very small group of economies, most of which have operated under very special circumstances. It is important to identify both near-term aspects (e.g., when the government adjusts its policy rate and regulates the issuance of government bonds) and longer-term aspects (e.g., how to implement entitlement programs) In this respect, the main objective of this study is to bridge the literature examining the impact of EPU with the literature on spillovers between sovereign bond markets at various maturities in countries around the world.
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