Explaining long-term bond yields synchronization dynamics in Europe

Abstract

We present a novel empirical assessment of the determinants of sovereign yield synchronization dynamics in the European Monetary Union. This topic has been seldom addressed in the existing macroeconometric literature. We use a time-varying measure of government bond yields synchronization and Bayesian Model Averaging methods to show that the persistence of synchronization measures differs significantly between GIIPS countries (Greece, Ireland, Italy, Portugal and Spain) and the rest of the monetary union, as well as across periods characterized by whether the zero lower bound of interest rates was binding or not. The degree of synchronization in inflation rates with the rest of the currency area is a robust predictor of the synchronization of sovereign yields, as opposed to economic fundamentals describing the fiscal positions of individual countries. An out-of-sample forecasting exercise reveals that accounting for the most relevant economic fundamentals can lead to improvements in the directional accuracy of the forecasts of yield synchronization rates for GIIPS countries.