Abstract
This paper provides an empirical assessment of the relationship between common European Union and country-specific risk factors of sovereign bond spreads for Central and Eastern European countries over the period of 2004-2014. The model, estimated using Pooled Mean Group techniques, that accounts for both common long-run determinants and cross-country heterogeneities in sovereign bond spreads, tends to suggest that country-specific and common factors are important in the long-run, but common European Union factors are the main determinants of bond spreads in the short-run, i.e., market volatility index series converges with changes of sovereign bond spreads and turns out to be the predominant factor in the short-run. Furthermore, countries with stronger fundamentals have a tendency for lower responsiveness to changes in global risk aversion.The decomposition of changes in spreads for the purpose to compare actual and estimated spreads specifies that during risk-on periods (when the increase of misalignment falls down) there is consistency for increasing of creditworthiness undervaluation.
Highlights
The government bond spreads that countries remunerate for borrowing in financial markets measure their costs of additional capital flows and produce a point of reference on their financial fragility and vulnerability
The most important single-country time series study for European transition economies was performed by Ebner (2009), who concluded that the external risk aversion, captured in this case by market volatility, as opposed to macroeconomic variables, was more important in explaining spreads
The results of the Pooled Mean Group (PMG) calculation on the initial sample of nine CEE countries identify that the government debt-to-GDP ratio, the equity market volatility in the euro area as well as the amount of general government interest payments on public debt and GDP ratio and real convergence measure are the main long-run determinants of spreads
Summary
The government bond spreads that countries remunerate for borrowing in financial markets measure their costs of additional capital flows and produce a point of reference on their financial fragility and vulnerability These features of government borrowing results have provided a great deal of empirical research in policy, business, and academic circles aimed at understanding the determinants. This paper estimates a model using Pooled Mean Group (PMG) techniques to determine the role of internal and external conditions on government bond spreads. This is basically a dynamic error correction model with heterogeneous cross-sectional coefficients in the short-run equations and homogeneous coefficients in the long-run relationship, with different short-run dynamics and adjustment towards the equilibrium. The rest of the paper is organised as follows: Section 2 reviews the related academic literature on describing the determinants of government bond spreads; Section 3 describes the data employed in the estimation; Section 4 outlines a brief description of the basic theoretical model; Section 5 reports and discusses the estimation results of the model; Section 6 represents the comparison of actual and estimated spreads and Section 7 summarizes the main findings and discusses the implications of the overall results for CEE countries
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