Euro Area Government Bond Research Articles

Evaluating the yield curve effects of central bank asset purchases under a forward-looking supply factor

The theoretical literature on term structure models emphasizes the importance of the expected absorption of duration risk during the residual life of term bonds in order to understand the yield curve effect of central banks’ government bond purchases. Motivated by this, we develop a forward-looking, long-horizon measure of euro area government bond supply net of Eurosystem holdings, and use it to estimate the impact of the ECB’s asset purchase programs in the context of a no-arbitrage affine term structure model. We find that an asset purchase shock equivalent to 10% of euro area GDP lowers the 10-year average yield of the euro area big-four by 59 basis points (bp) and the associated term premium by 50 bp. Applying the model to the risk-free (OIS) yield curve, the same shock lowers the 10-year rate and term premium by 35 and 26 bp, respectively.

Talking fragmentation away – Decoding the ’whatever it takes’ effect

In 2022, the ECB introduced a new instrument designed to combat fragmentation in euro area government bond yields. To assess the ECB’s effectiveness in addressing fragmentation through existing instruments, particularly communication, we turn to a pivotal historical event – Mario Draghi’s famous “whatever it takes” speech. Widely interpreted as a commitment by the ECB to act as a lender of last resort, this speech eased tensions in bond markets. Employing state-of-the-art computational linguistics, we create an index that quantifies the ECB’s commitment to act as a lender of last resort based on this historic speech. Our index highlights the ECB’s central role in stabilizing financial markets, especially during periods of heightened uncertainty.

Which exogenous driver is informative in forecasting European carbon volatility: Bond, commodity, stock or uncertainty?

This study relies on 45 exogenous drivers to improve the accuracy in forecasting EUA volatility. Several popular linear and nonlinear predictive regressions, including individual factor analysis, the combination forecast method, the diffusion index model and the supervised learning method, are used to generate volatility forecasts at the monthly frequency. Our empirical results reveal that the diffusion index model and combination forecast method can hardly drive the EUA volatility in a data-rich world owing to worse forecasting performance of individual factors; however, the supervised learning method can successfully predict the EUA volatility. Additionally, the WilderHill new energy global innovation index, Euro corporate bond return spread, GSCI gold index and Euro Area government bond yield spread can extremely drive EUA volatility in terms of individual factor analysis, frequency of variable selection and factor importance. Our findings provide crucial implications to market participants and emission companies, who should pay more attention to the price movement of European bond market, gold and clean energy.

Dispelling the shadow of fiscal dominance? Fiscal and monetary announcement effects for euro area sovereign spreads in the corona pandemic

We use event study regressions to compare the impact of monetary versus fiscal policy announcements on euro area government bond spreads in the unfolding Covid-19 pandemic. Throughout our specifications and robustness checks, we detect larger effects for monetary than for fiscal announcements. Among monetary policy instruments, the PEPP has the largest spread compressing effects. Comparing the announcement effects for fiscal crisis tools, Next Generation EU shows significant results in contrast to news on pure loan instruments. The relaxation of European fiscal rules through the activation of the emergency-escape clause under the Stability and Growth Pact is associated with rising spreads. We conclude that the stability of euro area bond markets in the presence of a severe solvency shock depends to a large extent on the Eurosystem’s unconstrained sovereign bond purchases. Our results suggest that fiscal support can play a stabilizing role if it includes, like Next Generation EU, a significant transfer component.

Central bank purchases of sovereign bonds in the euro area, the random walk hypothesis, and different measures of risk

Abstract The large purchase of public sector bonds (PSPP) by the ECB constitutes an interesting special case of quantitative easing (QE). It involved the purchase of risky, peripheral euro area government bonds—not by the ECB itself but by the national central banks at their own risk. The PSPP can be assimilated into a buy-back financed with senior debt, which should reduce the value of the remaining debt. Theory thus suggests that the PSPP should not be expected to have a positive impact on peripheral risk spreads. Empirical studies try to measure the impact of the asset purchases of central banks (QE) using the market reaction at the announcement date. The announcement effects are taken to be permanent because long-term rates are assumed to follow a random walk. We show that this assumption is not warranted for the risk spreads on bonds or the credit default swaps of peripheral euro area countries.

The assets’ pledgeability channel of unconventional monetary policy

AbstractWe identify a new channel of the monetary policy transmission that affects asset prices through the secured interbank market. Central bank’s open market operations, by changing the relative amount of securities and reserves, alter the amount of securities that can be used as collateral and, consequently, influence their prices. Ceteris paribus the magnitude of the effect depends on assets’ pledgeability properties (haircuts). We analyze the relation between yields of euro area government bonds, the haircuts applied to these assets and the relative amount of bonds and central banks reserves. The empirical evidence confirms that this channel is economically relevant.

QE in the euro area: Has the PSPP benefited peripheral bonds?

The Public Sector Purchase Programme of the euro area, PSPP, which started in 2015, constitutes an interesting special case of Quantitative Easing (QE) because it involved the purchase of peripheral euro area government bonds, which were clearly not riskless. Moreover, these purchases were undertaken by national central banks at their own risk. Intuition suggests, and a simple model confirms, that, ceteris paribus, large purchases by a central bank of the bonds of its own sovereign could increase the risk for the remaining private bond holders – if this purchase occurs within a monetary union where the national central banks have no autonomy left. Our empirical analysis suggests that risk premiums on peripheral bonds did not follow a random walk, contrary to what is assumed in event studies, implying that the announcement effects might not have been permanent. We find that the announcements of bond buying (and its implementation) did not change the stochastics of these premiums and had a smaller impact on CDS spreads which provide another measure of risk.

Redenomination risk in eurozone corporate bond spreads

We investigate the risk spillover from euro area government bond spreads (relative to a safe German government bond of similar maturity) to nonfinancial corporate bonds in France, the Netherlands (‘hard’ euro-area countries), and Italy, Portugal and Spain (‘soft’ euro-area countries). In addition to standard firm- and bond-specific determinants of corporate bonds (capturing liquidity and tax effects, and other euro area macroeconomic risks), we show that there is significant risk transfer from government bonds to the nonfinancial corporate sector. After decomposing the government bond spread into a default risk and a currency redenomination risk component, associated with a possible split in the euro, we find that redenomination risk has been a significant factor in the pricing of corporate bonds, particularly in the ‘soft’ euro-area countries.

Spillover Effects of Sovereign Bond Purchases in the Euro Area

This paper investigates cross-border spillover effects from the Eurosystem’s Public Sector Purchase Programme (PSPP) on euro area government bond yields. We distinguish between the direct effects of domestic bond purchases by national central banks and the indirect effects from bond purchases by national central banks in other euro area countries over the period March 2015 - December 2018. The results reveal substantial spillover effects across the euro area, providing evidence for strong arbitrage within the euro area. These spillover effects are particularly large for long-term bonds and for bonds issued by non-core countries. The larger impact of spillovers in these cases can be explained by investors rebalancing towards higher yielding government bonds. In addition, purchases under PSPP had their largest impact on bond yields in 2015.

The impact of size, composition and duration of the central bank balance sheet on inflation expectations and market prices

We analyse the effects of announcements of changes in the Eurosystem’s balance sheet size, duration and composition on inflation expectations, the exchange rate, the 10-year euro area government bond yield and stock returns, using local projections. We explicitly take into account interaction effects between the three balance sheet dimensions. We provide evidence for the duration extraction channel of monetary policy transmission as we find that the bond yield is sensitive to the combined impact of shocks to balance sheet size and duration. The exchange rate is also affected by a joint size-duration shock. Moreover, the bond yield and exchange rate are sensitive to the joint effect of changes in size and composition. The results indicate that interactions between balance sheet dimensions matter.

The Impact of Size, Composition and Duration of the Central Bank Balance Sheet on Inflation Expectations and Market Prices

We analyse the effects of announcements of changes in the Eurosystem’s balance sheet size, duration and composition on inflation expectations, the exchange rate and the 10-year euro area government bond yield, using local projections. We explicitly take into account interaction effects between the three balance sheet dimensions. We provide evidence for the duration extraction channel of monetary policy transmission, as we find that the bond yield is sensitive to the combined impact of shocks to balance sheet size and duration. The exchange rate is also affected by a joint size-duration shock. Moreover, the bond yield and exchange rate are sensitive to the joint effect of changes in size and composition. The results indicate that interactions between balance sheet dimensions matter.

On the credit and exchange rate channels of central bank asset purchases in a monetary union

Throughout the euro area crisis, financial fragmentation across jurisdictions became a prime concern for the single monetary policy. The ECB broadened the scope of its instruments and enacted a series of non-standard measures to engineer an appropriate degree of policy accommodation. The transmission of these measures through the currency union remained highly dependent on the financial structure and conditions prevailing in various regions. This paper explores the country-specific macroeconomic transmission of selected non-standard measures from the ECB using a global DSGE model with a rich financial sector: we extend the six-region multi-country model of Darracq Pariès et al. (2016), introducing credit and exchange rate channels for central bank asset purchases. The portfolio rebalancing frictions are calibrated to match the sovereign yield and exchange rate responses after ECB's Asset Purchase Programme (APP) first announcement. The domestic transmission of the APP through the credit intermediation chain is significant and quite heterogenous across the largest euro area countries. The introduction of global portfolio frictions on euro area government bond holdings by international investors opens up for a larger depreciation of the euro. The interaction between international and domestic channels affect the magnitude and the cross-country distribution of the APP impact.

Tail risk in the European sovereign bond market during the financial crises: Detecting the influence of the European Central Bank

Since 2008, the European Central Bank (ECB) is conducting an expansionary monetary policy on an unprecedented scale. The consequence is a historical low interest rate environment in the eurozone and inflated prices for the majority of euro area government bonds. This paper presents a study of the tail behavior of triple-A rated euro area government bonds during the financial crisis 2007/08, the European sovereign debt crisis and the episode of expansionary monetary policy by the ECB. First, the analysis determines whether daily returns of euro area government bonds exhibit fat tails. Second, tests are conducted for variation in tail risk among euro area government bonds with different maturities. Third, it is estimated whether the tail behavior has significantly changed during the financial crisis, the European sovereign debt crisis and the resulting market interventions by the ECB. The study is based on daily data of the spot yield curve for triple-A rated euro area government bonds with a remaining maturity from three months to thirty years. Evidence is found for fat tails for the left-and right-hand side of the return distribution for all considered bond maturities in the sample. Moreover, the results indicate a convex term structure of tail risks and a structural change in the tail behavior of short-term bonds with a remaining maturity of less than one year during the past two crises. In contrast, the test outcomes for the majority of the considered long-term bonds do not indicate any significant change in the tail behavior, despite the introduction of unconventional asset purchase programs by the ECB which directly target these securities.

Country-specific euro area government bond yield reactions to ECB’s non-standard monetary policy program announcements

Abstract This paper employs event study methods to evaluate the effects of ECB’s non-standard monetary policy program announcements on 10-year government bond yields of 11 euro area member states. Measurable effects of announcements arise with a one-day delay meaning that government bond markets take some time to react to ECB announcements. The country-specific extent of yield reduction seems inversely related to the solvency rating of the corresponding countries. The spread between core and periphery countries reduces because of a stronger decrease in the latter. This result is confirmed by letting the announcement variable interact with the current spread level.

Impact of the Asset Purchase Programme on euro area government bond yields using market news

Assessing the impact on sovereign yields of the euro area Asset Purchase Programme (APP) is challenging, because the monetary policy announcement in January 2015 was already implicitly communicated to the market in the second half of 2014. To identify the APP effect, we construct an index which computes the intensity of this discussion in Bloomberg. The econometric results, which are based on real time vintages, suggest that the so-called stock effect with purchases worth about 10% of GDP reduced the GDP-weighted 10-year euro area sovereign yield by 72 basis points, which is equivalent to effects estimated for US and UK programmes, and much larger than those suggested by event studies for the euro area.

On the Credit and Exchange Rate Channels of Central Bank Asset Purchases in a Monetary Union

Through the euro area crisis, financial fragmentation across jurisdictions became a prime concern for the single monetary policy. The ECB broadened the scope of its instruments and enacted a series of non-standard measures to engineer an appropriate degree of policy accommodation. The transmission of these measures through the currency union remained highly dependent on the financial structure and conditions prevailing in various regions. This paper explores the country-specific macroeconomic transmission of selected non-standard measures from the ECB using a global DSGE model with a rich financial sector: we extend the six-region multi-country model of Darracq Paries et al. (2016), introducing credit and exchange rate channels for central bank asset purchases. The portfolio rebalancing frictions are calibrated to match the sovereign yield and exchange rate responses after ECB's Asset Purchase Programme (APP) first announcement. The domestic transmission of the APP through the credit intermediation chain is significant and quite heterogeneous across the largest euro area countries. The introduction of global portfolio frictions on euro area government bond holdings by international investors opens up for a larger depreciation of the euro. The interaction between international and domestic channels affect the magnitude and the cross-country distribution of the APP impact.

Chasing unicorns: The European single safe asset project

For the past 20 years, Economic and Monetary Union (EMU) institutions have sought to engineer a single safe asset that would provide a credible store of value for capital market participants. Before 2008, the European Central Bank used shadow banking to create a single safe asset that we term shadow money, and in doing so also erased borders between Euro area government bond markets. Lacking appropriate ECB support, shadow euros could not withstand the pressures of the global financial crisis and brought down several periphery euro government bonds with them. Two new plans, the Capital Markets Union and the Sovereign Bond-Backed Securities, again turn to shadow banking, this time by using securitization to generate an entirely private safe asset or a public–private safe asset. Such plans cannot solve the enduring predicament of EMU’s bond markets architecture: that Member States have competed for investors (liquidity) since the introduction of the euro, betraying a deep hostility towards collective political solutions to the single safe asset problem. Technocratic-led, market-based initiatives need to persuade EMU states that there is little threat to their ability to issue debt in liquid markets. Without ECB interventions, market-based engineering of single safe assets runs the danger of repeatedly destabilizing national bond markets.

ECB Monetary Policy and Euro Area Governance: Collateral Eligibility Criteria for Sovereign Debt

Since the beginning of the crisis, euro area governments have experienced greater fiscal stress than governments of advanced economies outside the euro area with weaker fiscal fundamentals. What has been the source of this fragility and how can it be corrected? The cause of the instability in euro area government bond markets can be traced to a discretionary decision taken by the ECB in 2005, in the aftermath of the failure of the Stability and Growth Pact. The decision effectively delegated the determination of collateral eligibility of euro area government debt to private credit rating agencies and eventually compromised the safe asset status of government debt for most member states. This paper examines how the ECB inadvertently planted the seeds of the euro crisis and discusses how the resulting tensions can be reversed.

Expected Issuance Fees and Market Liquidity

This paper studies the impact of expected issuance fees on market liquidity in the Euro-area government bond market. Investment banks have a dual role as primary dealer in the secondary market as well as competitor for lead manager in the primary market. Primary dealers have the incentive to increase liquidity due to competition for issuance fees because lead managers are selected based on their liquidity provision in the secondary market. We find that the expected issuance fee is significantly related to market liquidity. Issuance fee driven liquidity is especially strong for countries with high funding needs, in periods of high uncertainty, and for bonds with high search costs.

The Collateral Channel of Unconventional Monetary Policy

We build a general equilibrium model - along the lines of Williamson (2012) - where financial assets can be used as collateral in secured interbank markets to obtain reserves (central bank money). In this framework, frictions in the exchange process give rise to a liquidity premium for assets. An open market operation that provides reserves in exchange for assets decreases the availability of collateral by increasing its liquidity premium (and decreasing its return). The magnitude of the effect depends on assets' pledgeability properties (haircuts). We explore the positive implications of the model shown in the data. Focusing on the period 2009-2014, we analyse the relationship between yields of euro-area government bonds and the relative amount of bonds and central bank reserves held by the euro-area banking sector. We find evidence consistent with our model: yields decrease when reserves increase relative to bonds, with the effect being stronger at lower levels of haircuts. The results are confirmed after several robustness checks.