Long-term Sovereign Research Articles

Climate policy uncertainty and its impact on the volatility, correlation, and hedging of sovereign and green bonds

This study develops monthly climate policy uncertainty (CPU) indexes for 21 economies and three global CPU indexes to evaluate their effects on the long-term sovereign and green bond volatilities and the long-term sovereign-green bond correlation. Findings show significant increases in the CPU indexes during key climate policy events. Using the extended GARCH-MIDAS-CPU and DCC-MIDAS-CPU models, it finds that CPU significantly affects sovereign bond volatility following the Paris Agreement. Green bonds are more effective as hedging tools in the sovereign bond markets of emerging markets and developing economies than in developed ones, especially post-Paris Agreement. Diversified portfolios including green bonds offer superior hedging effectiveness. This study highlights the pivotal role of green bonds in managing CPU and promoting sustainable development goals.

Balance sheet expansionary policies in the euro area: Macroeconomic impacts and a vulnerable versus non-vulnerable comparison

This paper investigates the impacts and heterogeneity of the ECB's large-scale asset purchasing programs of sovereign securities on real GDP, inflation, long-term sovereign bond yields, systemic stress, and the unemployment rate. A structural Bayesian VAR model with six endogenous variables was estimated for 11 euro area countries over the period 2012:M1 to 2023:M12. To provide robustness to the results, a structural panel BVAR model is estimated, enabling a straightforward comparison of impulse responses of vulnerable and non-vulnerable countries. The results suggest that the magnitudes of impulse responses were more favorable in countries that were more economically and financially vulnerable. These findings underscore that financial and economic distress was a source of heterogeneity in the responses to large scale asset purchases within the euro area.

“Green” fiscal policy measures and nonstandard monetary policy in the euro area

The paper builds a two-region New Keynesian model with a complex energy production sector. It is calibrated to the euro area (EA) and the rest of the world. It simulates the gradual introduction of a carbon tax in the EA and finds recessionary and disinflationary effects. When green energy is subsidized and labor taxes are reduced, the recession becomes much smaller. As green fiscal policy is disinflationary in the model, assuming a binding effective lower bound on the monetary policy rate may reduce these positive effects. This can be prevented by allowing the central bank to purchase long-term sovereign bonds for monetary policy reasons.

Investigating the muti-scaling properties and connectedness of the sovereign bond yields: Hurst exponent and network analysis approach

Using daily yield data of 14 sovereign bond markets from emerging and developed economies from July 10, 2000, to July 10, 2022, we examine their scaling properties using generalized Hurst exponent and spectral density analysis and investigate the connectedness based on a network analysis approach. We consider the yields of 2-year and 10-year bond yields to investigate the scaling properties for short- and long-term sovereign bonds. This selection also allows us to examine sovereign bond spreads with respect to the USA. We also use regularized partial correlation network analysis to connect different countries in communities based on yields. We find that the scaling behavior of the bond yields for both terms fits well using the Hurst exponent and spectral analysis confirms this finding. Moreover, we also find that even though bonds in both cohorts show anti-persistent behavior except that of the USA, the developed economies' bond yields are relatively less anti-persistent as compared to those of emerging economies. The networks of both the 2-year and 10-year yields indicate community formation in various countries which provides diversification benefits to the investors. Most of the emerging countries are classified into one community in the long-tenure bonds as well but this concentration is more evident in the short-tenure bonds.

Do green financial policies offset the climate transition risk penalty imposed on long-term sovereign bond yields?

Asset valuations in high-carbon sectors face significant corrections due to climate risks. This paper specifically analyses whether markets impose a penalty on long-term sovereign bonds issued by countries facing higher climate-related transition risk while rewarding those that have implemented green financial policies to mitigate these risks. We find that higher carbon dioxide emissions and a lower sustainable development score (both proxies for transition risks) lead to an increase in long-term sovereign bond yields. However, the presence of green financial policies appears to offset this climate transition risk premium.

Long-term sovereign debt: A steady state analysis

A model of long-term sovereign debt with a fiscal rule and endogenous default is explored in which debt maturity governs the number of risky steady states. Generally, there is a good steady state with high investment and low indebtedness and default frequencies, and a bad steady state with the reverse. The multiplicity arises when maturity tames an aggressive feedback loop that emerges in the sovereign budget set between debt service and required issuance as expected default frequencies rise. This feedback loop delivers a unique risky steady state at shorter maturities. Local dynamics and policy consequences are explored quantitatively.

Long-term sovereign interest rates in Czechia, Hungary and Poland: a comparative assessment with an affine term structure model

Abstract This paper provides a comparative evaluation of the behaviour of long-term sovereign yields in Czechia, Hungary and Poland from 2001 to 2019. An affine term structure model developed by Adrian, Crump and Moench (2013) is used as an empirical framework for the decomposition of the bond yields into term premium and risk-neutral components. We document a substantial compression in term premia which started in Central European economies around 2013 and played a decisive role in the changes that occurred in 10-year sovereign yields. This pattern, however, was more prevalent in Czechia and Poland than in Hungary. We show that long-term rates in all three economies remained higher than in Germany due to relatively large risk-neutral components. Nevertheless, cross-country correlations became increasingly dependent on term premium dynamics, both among Central European economies and between each of them and Germany. These results are robust to bias-correction in the baseline models and interpreted in the light of the general interest rates decline in the global economy. Potential policy implications are also discussed.

Forecasting output growth of advanced economies over eight centuries: The role of gold market volatility as a proxy of global uncertainty

In this paper, we develop a proxy for global uncertainty based on the volatility of gold market over the annual periods from 1311 to 2019, and then use this proxy metric to forecast historical growth-rates for eight advanced economies, namely, France, Germany, Holland, Italy, Japan, Spain, the United Kingdom (UK), and the United States (US). We find that for the within-sample period, uncertainty negatively impacts output growth, but more importantly, over the out-of-sample period, gold market volatility produces statistically significant forecasting gains. Our findings are also robust to an alternative measure of uncertainty based on the volatility of the changes in long-term sovereign real-rates over the period 1315–2019. These historical results have important implications for investors and policymakers in the current context in which high frequency gold-price data are available.

The COVID-19 shock and long-term interest rates in emerging market economies

Motivated by a divergent behavior of long-term sovereign bond yields across emerging market economies in the onset of the COVID-19 pandemic, we employ the Bayesian model averaging to uncover the country-specific factors that explain those differences. The most pronounced determinants of a country’s vulnerability to the COVID-19 shock were: (a) low GDP dynamics and (b) high sensitivity of bond yields to VIX in the period preceding the pandemic. Our results speak to the role of growth fundamentals in building-up the exposure to crises in emerging markets. They also signify a persistent differentiation of emerging economies by international investors.

Risk premia and the European government bond market: new empirical evidence and some thoughts from the perspective of the life insurance industry

We study yield spreads between government bonds in the European Monetary Union. This segment of the global fixed income market is of particular importance for insurance companies in Europe. Our empirical research strategy is inspired by Gunay (2020) who has analyzed the relationship between credit and liquidity risk in the United States using Granger causality tests. More specifically, we employ the procedure developed by Toda and Yamamoto (1995) to test for Granger causality among yield spreads in five different member countries of the European Monetary Union (namely Austria, Belgium, France, Italy and Ireland) relative to Germany. We examine interest rate data from bonds with three different maturities (5, 10 and 30 years). Given the importance of long-term bonds as asset class for European life insurers and pension funds, the empirical results from the often ignored market for government bonds with a maturity of 30 years should be of interest. With regard to long-term sovereign debt, there is no evidence for Granger causality among the time series examined here. Consequently, the risk premia required by investors to hold government bonds of one specific member country of the EMU do not help to forecast the risk premia that have to be paid by other countries. Given the structure of their liabilities, this empirical finding should be of high relevance for portfolio and risk managers in the European life insurance industry and in pension funds. With regard to the yield spreads to be observed in the market for 10-year government bonds, there seems to be no clear picture. Focusing on fixed income securities with a maturity of 5 years, there is one very interesting empirical finding. The test results reported here seem to imply that there is unidirectional Granger causality running from the yield spreads in all other four countries to Austria. Given that Austria is a comparably small country which is assumed to be in a fiscally stable position, this result could be interpreted as evidence for credit risk premia as being helpful to forecast liquidity risk premia in the market for medium-term government bonds issued by member states of the European Monetary Union.

Macroeconomic determinants of long-term sovereign bond yields in South Africa

This paper seeks to analyse the impact of government debt and other macroeconomic variables on the long term bond yield for South Africa. Recent increases in the government budget deficit and its c...

EXAMINING THE SOURCES OF SOVEREIGN RISK FOR SOUTH AFRICA: A TIME VARYING FLEXIBLE LEAST SQUARES APPROACH

This paper analyzes the determinants of the South African long-term sovereign bond yield spread using 10-year bond yield spread. We employ the Auto-Regressive Distributed Lag and Flexible Least Squares techniques to demonstrate the impact of macroeconomic and financial variables on the yield spread. Our results show that the short-term interest rate is positively related to the bond yield spread both in the short and long run. We also establish a long-run positive influence of government debt on the bond yield spread whilst on the other hand, economic growth, the nominal effective exchange rate, stock market returns and bank credit all have a negative impact on the bond yield spread in the long run. We examine the time varying coefficient of government debt and reveal that the long-run impact of government debt has varied over the period under analysis. Time varying coefficients capture some important periods in the history of the South African economy, indicatingthat underlying economic conditions and exogenous shocks influence the determination of sovereign risk. Our results imply the need for synchronization of fiscal and monetary policy. In addition, economic policy should address economic growth and macroeconomic instability to complement deleveraging efforts aimed at curbing sovereign credit risk.

An analysis of Granger causality between sovereign credit rating and economic growth in Sub-Saharan Africa

Interest in the relationship between credit rating and economic growth is growing as emerging economies increasingly integrate into international financial markets. Without credit ratings, developing economies would not have been able to successfully issue their sovereign bonds to support economic growth. Therefore, this paper examines a causality relationship between Standard & Poor’s long-term foreign currency sovereign credit ratings and economic growth in 19 Sub-Saharan countries over the period from 2003 to 2018. The results of the Granger causality tests show a unidirectional causality from sovereign credit ratings to economic growth, not vice versa. This implies that economic growth is not significant in determining sovereign credit ratings. It can thus be concluded from these findings that sovereign credit ratings are proactive actions by rating agencies that are relevant in determining future economic growth. Thus, investors benefit from utilizing credit ratings to prevent inherent information asymmetry in fundamental economic factors. Therefore, it is important for policy makers to pay attention to sovereign credit ratings when formulating macroeconomic policies.

European spreads at the interest rate lower bound

This paper analyzes the effect of the interest rate lower bound on long-term sovereign bond spreads in the euro area. We specify a joint shadow rate term structure model for the risk-free, the German, and the Italian sovereign yield curves. In our model, the behavior of long-term spreads becomes strongly nonlinear in the underlying factors when interest rates are close to the lower bound, which occurs in the data since the beginning of 2012. We fit the model via Quasi-Maximum Likelihood and show three consequences of the nonlinear behavior of sovereign spreads: (i) they are asymmetrically distributed, (ii) they are affected by (possibly exogenous) changes in the lower bound, and (iii) they become less informative about sovereign risk than when interest rates are far from the lower bound. Shadow spreads, however, still provide reliable information.

Determinants of Vietnam Government Bond Yield Volatility: A GARCH Approach

This empirical research aims to identify the relationship between fiscal and financial macroeconomic fundamentals and the volatility of government bonds' borrowing cost in an emerging country - Vietnam. The study covers the period from July 2006 to December 2019 and it is based on a sample of 1-year, 3-year, and 5-year government bonds, which represent short-term, medium-term and long-term sovereign bonds in Vietnam, respectively. The Generalized AutoRegressive Conditional Heteroskedasticity (GARCH) model and its derivatives such as EGARCH and TGARCH are applied on monthly dataset to examine and suggest a significant effect of fiscal and financial determinants of bond yield volatility. The findings of this study indicate that the variation of Vietnam government bond yields is in compliance with the theories of term structure of interest rate. The results also show that a proportion of the variation in the yields on Vietnam government bonds is attributed to the interest rate itself in the previous period, base rate, foreign interest rate, return of the stock market, fiscal deficit, public debt, and current account balance. Our results could be helpful in the macroeconomic policy formulation for policy-makers and in the investment practice for investors regarding the prediction of bond yield volatility.

Macroeconomic determinants of Long-term Sovereign bond yields in South Africa

Recent developments in South Africa warrant a complete understanding of the fiscal dynamics within the economy. The government budget deficit has soured to unprecedented levels pushing the debt to GDP ratio above 60%. We seek to reveal in this paper the impact this has on the South African long term bond yield, which represents the cost of borrowing to government. Our approach entails investigating the determinants of the long term bond yield for South Africa using linear and non-linear single equation Auto-regressive distributed lag (ARDL) approach. Our results show that the short-term interest rate is the major determinant of long term yields in South Africa, showing a persistent positive and statistically significant relationship with the long term yield. Furthermore, we find that government debt and the US long term yield are positively related to long term bond yields both in the short and long-run. Our tests for linearity reveal that the short-term interest rate has a non-linear relationship with the long-term bond yield. The rate of inflation, nominal exchange rate and bank credit all have negative impacts on the bond yield in the long-run. Economic growth has a positive impact in the short run but impact the long-term yield negatively in the long-run. We suggest a coordinated approach between monetary policy and fiscal policy authorities, a systematic program of deleveraging and implementation of structural strategies aimed at increasing production.

Eurozone Crisis and Banks’ Creditworthiness: What is New for Credit Default Swap Spread Determinants?

The article analyses banks’ credit default swap (CDS) spread determinants, in light of the Eurozone debt crisis. The attention to this aspect is due to the very linkage between banking and sovereign sectors particularly evident during the aforementioned crisis. The study is conducted on a sample of Eurozone banks over the period 2009–2014 through a feasible generalized least squares (FGLS) linear panel data regression. The variables adopted are both balance sheet ratios and macroeconomic factors. The main results confirm the attention pointed at the influence of public conditions to the banking sector, as proved by the significance of variables like the 10-year bond yields or the long-term sovereign rating. It is also interesting to observe the output dealing with public debt, which may suggest opportunities not only of investment but also of speculation for banks on the debt itself. Balance sheet ratios, instead, are not significant. Our study is an additional contribution to the strand of literature that analyses the strong interconnections between the riskiness of banks and the public sector and it is a suggestion to proceed the research with a deeper analysis on systemic risk and its impact on banking CDS spread.

Do Long-Term Foreign Currency Sovereign Credit Ratings Positively Affect Bond and Equity Market Efficiency in Africa

This study investigates the weak-form efficiency of long-term foreign currency denominated bonds and stocks in incorporating long-term foreign currency sovereign credit rating announcements in 19 African countries over the period of 1994 to 2014. The results of Ljung-Box Q autocorrelation, runs and variance ratio tests find that sovereign credit ratings do not significantly impact bond market efficiency. In contrast, stock markets show evidence of weak form efficiency implying that long-term sovereign credit ratings positively affect equities market efficiency in Africa.

Do long-term foreign currency sovereign credit ratings positively affect bond and equity market efficiency in Africa

Do long-term foreign currency sovereign credit ratings positively affect bond and equity market efficiency in Africa

The impact of sovereign credit rating changes on government bond yields in South Africa

This study applies an event study analysis on Standard & Poor's (S&P), Fitch and Moody's sovereign credit ratings for South Africa over the period 2007 to 2018 to investigate the impact of long-term foreign currency sovereign credit ratings changes on 30-year sovereign bond yield. Results of the analysis find a generally significant increase in bond yields before, during and after credit rating downgrades and negative outlook events. However, there was no statistically significant impact on bond yields associated with upgrades and positive outlook events. It is thus concluded that investors in South Africa's long-term bonds are more sensitive to negative credit rating events, which are mainly driven by structural problems in the economy. This paper recommends monetary and fiscal authorities to address the concerns raised by rating agencies in review reports leading to negative outlook and downgrades before they become more apparent to trigger negative rating actions.