Yield Spread Determinants & Reaction to Negative Event-shocks and Downgrades: The Case of Greece

Abstract

The purpose of my study is to investigate the significance in the determination and worseness of ten year government bond yields spreads as well as the variation in the level of these spreads, factors like political risk and sovereign downgrades, considered as political and economic negative shocks in Greek economy during financial and public sector’s debt crisis. By extension to the main research, it is examined if shocks affected yields of two key sub-indexes of Athens Stock Exchange, ATHEX/FTSE large cap and ATHEX/Banks. The study extends from 1/1/2008 to 8/28/2015. My study is conducted in two stages, with similar goals. In this paper, I firstly investigate the role of significant, negatively signed political and economic events as well as sovereign downgrades, concerning Greece, in the determination of Greek ten-year bond spreads. In addition to the main research, I examine the influence of these negative shock-events in the yields of ATHEX/FTSE large cap index and ATHEX/Banks index. For this purpose, I make a series of regressions, since most studies analyzing the determinants of bond yield spreads rely on simple linear regression models and use OLS method of regression, as well. Secondly, I make an event-study, in Excel, on cumulative yields of the two latter indexes and on the yields of Greek bonds’ spreads and their movements ten days before and ten days after events and credit ratings that took place throughout the sample period. For the needs of the study, I reassess all models as well as the event study for three sub-time periods, namely “pre-crisis” period, from 1/1/2008 to 5/5/2010, “mid-crisis” period, from 5/6/2010 to 12/16/2014 and “new-crisis” period, from 12/17/2014 to 8/28/2015. Overall, the results that gave this empirical analysis seem to be very useful for politicians, for market makers and for market participants. It is mentioned that the evidence and conclusions occurred in the first part of this empirical analysis are confirmed, since they are in agreement with the findings of the event study that is in the second part of my research. Concluding, Greek government bond yield spreads are influenced from shock events and downgrades, mainly, during new crisis and pre-crisis period, respectively. Throughout the mid-crisis period neither yields of Athens stock Exchange indexes nor negatively signed shock events, including ratings, could cause a significant movement in spreads. This maybe means that, during this period, only other risk, fundamental or macroeconomic parameters could affect spreads. Especially from results of event study occurs the exact way that bond yield spreads and the yields of ATHEX/FTSE large cap and ATHEX/Banks indexes reacted ten days before and since an event-shock happened. The observed significant movements of spreads and the abnormal yields of indexes before the shock maybe indicates a leakage of information or a good prediction ability of market, while the noticed abnormal movements of spreads and yields after the event-day reflect the way of investors’ reaction in shocks.