Measuring Financial Fragmentation in the Euro Area Corporate Bond Market

Guillaume Horny,Simone Manganelli,Benoit Mojon

doi:10.3390/jrfm11040074

Guillaume Horny, Simone Manganelli + Show 1 more

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https://doi.org/10.3390/jrfm11040074

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Abstract

This paper analyses the determinants of euro area non-financial corporate bonds since the early 2000s, so as to gauge deviations from the law of one price. We decompose the spread between the yield of German, French, Italian and Spanish corporate bonds vis-à-vis the German Bund of similar maturity into country, credit and duration risk premia components via dummy regressions. We highlight three main findings. First, the initial phase of the financial crisis (2008–2009) caused an overall increase in credit risk premia. Since the beginning of 2013 credit risk premia are back to levels comparable to those preceding the financial crisis. Second, at the height of the euro area sovereign crisis (2011–2012), high credit risk premia were accompanied by strong and persistent signs of market fragmentation in Italy and Spain (but not in France). This fragmentation has reached its peak in the second half of 2012 and has started to recede only after the announcement of the OMT. Third, we provide a simple measure of financial integration across the big 4 member states of the euro area.

Highlights

The purpose of this paper is to build price indicators of deviation from the law of one price for corporate bonds within the euro area
This article uses corporate bond markets to assess the fragmentation of the euro area financial ma6rk. eCtos.nWcluesdioencosmpose yields of non-financial corporate bonds to disentangle country-specific premia from other observable determinants of risk
We examine the performance of our approach under various changes in the modelling strategy and provide simple measure of financial fragmentation

Summary

Introduction

The purpose of this paper is to build price indicators of deviation from the law of one price for corporate bonds within the euro area. The yield on corporate bonds with similar credit rating and maturity structure (our main proxies for risk profiles) should not be significantly affected by the country where the bond is issued. The main contribution of this paper is to estimate country risk premia in the yields of non-financial corporate bonds for a panel of 719 individual bonds issued by 153 non-financial corporates, controlling for credit and maturity risk. Corporate bonds issued in Italy and Spain bear higher yields than similar bonds issued in France and Germany. During the most acute periods of the sovereign debt crisis, corporate bondholders have required higher yields to hold corporate bonds issued in Italy and Spain

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