Sovereign Bond Market Research Articles

Beyond Spreads: Measuring Sovereign Market Stress in the Euro Area

In this paper we propose a composite indicator that measures multidimensional sovereign bond market stress in the euro area as a whole and in individual euro area member states. It integrates measures of credit risk, volatility and liquidity at short-term and long-term bond maturities into a broad measure of sovereign market stress. The statistical framework builds on that of the ECB’s Composite Indicator of Systemic Stress (CISS) developed by Hollo, Kremer and Lo Duca (2012), so that we call our metric the Composite Indicator of Systemic Sovereign Stress or “SovCISS”. We implement the SovCISS for eleven euro area member states and also present four options of a SovCISS for the entire monetary union. In addition, we suggest a linear decomposition of the SovCISS, singling out contributions of the different components and of the time-varying correlations across these components. Comparing develoments in the SovCISS and the CISS over the crisis period clearly illustrates the usefulness of the latter for the real-time monitoring of systemic instabilities in the financial system as a whole. Finally, an application of the country-specific SovCISS indicators to the VAR-based spillover literature suggests that stress mainly originates from a few euro area countries, and that spillover patterns vary over time. JEL Classification: C43, E44, F45, G01, H63

On International Integration of Emerging Sovereign Bond Markets

The paper investigates the international integration of EM sovereign dollar-denominated and local-currency bond markets. Factor analysis is used to examine movements in sovereign bond yields and common sources of yield variation. The results suggest that EM dollar-denominated sovereign debt markets are highly integrated; a single common factor that is highly correlated with US and EU interest rates explains, on average, about 80 percent of the total variability in yields. EM sovereign local currency bond markets are not as internationally integrated, and three common factors explain about 74 percent of the total variability. But a factor highly correlated with US and EU interest rates still explains 63 percent of the yield variation accounted for by common factors. That said, there is some diversity among EM countries in the importance of common factors in affecting sovereign debt yields.

The Impact of Government Debt Supply on Bond Market Liquidity: An Empirical Analysis of the Canadian Market

This paper finds that in the Canadian sovereign bond market, a larger increase in government maturity-weighted debt supply is associated with lower bond market liquidity over the subsequent month. The result is both statistically and economically significant, stronger for the long-term than the short-term sector, and is robust when other macro factors are controlled for. The result is consistent with the interpretation that risk-averse dealers tend to provide less liquidity to the market when facing increased duration risks brought by large debt issuance. The fact that the newly issued bonds are highly illiquid may also contribute to the impact of debt supply on market liquidity.

Modelling illiquidity spillovers with Hawkes processes: an application to the sovereign bond market

Modelling the dynamics of (il)liquidity across assets is an important yet complicated task, especially when considering significant deteriorations of liquidity conditions. Here, we propose a peak-over-threshold method to identify abrupt liquidity drops from limit order book data and we model the time-series of these illiquidity events across multiple assets as a multivariate Hawkes process. This allows us to quantify both the self-excitation of extreme changes of liquidity in the same asset (illiquidity spirals) and the cross-excitation across different assets (illiquidity spillovers). Applying the method to the MTS sovereign bond market, we find significant evidence for both illiquidity spillovers and spirals. The proportion of shocks explained by illiquidity spillovers roughly doubles from 2011 to 2015, suggesting an increased synchronization of extreme illiquidity across assets.

The Price Discovery Mechanism between Sovereign Bond and Sovereign CDS Market: Studies in Selected Countries

This paper employs the multivariate VAR model to examine the mechanic work of price discovery process between sovereign CDS market and the associated sovereign bond market in contexts of five European and Asian countries, including Vietnam, Korea, Portugal, Italy and France from the beginning of 2008 to the end of April, 2017. The study accentuates on three aspects: the short-term interaction nexus between the sovereign CDS and the associated-sovereign bond market, the long-term co-movement between them and the discovery of which market plays the leading role in the pricing process. The results evidence the short-run and long-run relationship for the two markets. Particularly, the empirical test results support for the predominant role of the sovereign CDS market in the price discovery process in the bulk of sample entities. This might suggests for the governments to use CDS prices as the future indicator for predicting the volatility of debt markets.

Sovereign Credit Rating Changes and Its Impact on Financial Markets of Europe during Debt Crisis Period in Greece and Ireland

The purpose of this study is to examine the impact of sovereign credit rating changes on financial markets using database of two countries (Greece, Ireland) in the European union over the period March, 2008-Dec, 2015. By analyzing the influence of sovereign credit rating on bond market yield We also examine the correlation between sovereign credit rating and bond market yield of each country during crisis period. Quarterly basis data of all variables is used in the research. By using regression analysis with Durbin Watson test and Pearson correlation for each country financial markets the findings indicated that sovereign credit rating has a significant impact on bond markets. Sovereign ratings are negatively correlated with Bond yield in both countries. The finding summarized that credit rating has a major influence on financial markets during crisis period.

Freeze and Bid-Ask Spread in the Sovereign Bond Market

We describe a model for two market-makers in the sovereign bond market. The paper gives special importance to the way payments are decided and reflects the cost of securities issuance and trading, a usually small and neglected component of the bond price in normal times. The model generates a dynamic of the bid-ask spread which depends on the discount rate of utility of the market-makers. The novelty of the paper consists in modelling the discount rate of utility as a function depending on fundamentals and the possible changes in the overall risk aversion in the market. The latter aspect is modelled as a martingale process and called sentiment process. We then obtain a solution for our model that can qualitatively mimic the decrease of turnover and the related increase of spread observed in periods of financial uncertainty.

Benchmarking liquidity proxies: The case of EU sovereign bonds

We examine effective measures of liquidity in the context of EU sovereign bonds and the Basel III regulatory framework. We observe that the empirical correlations between benchmarks and proxies are typically very low and in general become weaker as the frequency over which these relationships are examined becomes higher, and that the relative strength of the various proxies may change with the frequency considered. The main implications of our results for the EU sovereign bond market are (i) the use of liquidity proxies may lead to erroneous conclusions; (ii) any liquidity measure needs to be assessed against the relevant timeframe for conversion into cash; and (iii) the end-of-day spread is the best performing proxy across different frequencies.

Variation in Boilerplate: Rational Design or Random Mutation?

Standard contract doctrine presumes that sophisticated contracting parties choose their terminology carefully because they want courts or counterparts to understand the precise meaning they intend to convey. The implication of this “rational design” model of commercial contracting behavior is that courts should pay close attention to the plain or ordinary meaning of the language in a standardized term and interpret observed changes in terminology as embodying new meaning that varies from the original formulation. Using a study of the sovereign bond market, we examine the rational design model as applied to standard-form contracting. In NML v. Argentina, federal courts in New York attached great weight to the precise phrasing of the boilerplate contract terms at issue. The industry promptly condemned the decision for endorsing a supposedly erroneous interpretation of a variant of a hoary boilerplate clause. Utilizing data on how contracting practices responded to the courts’ decisions, we ask whether the market response indicates that parties in fact intended the variations in their standard contract language to embody different meanings. The data support a model of evolution of boilerplate language that is closer to random mutation rather than rational design.

The Sovereign Debt Crisis: Rebalancing or Freezes?

Using high-frequency data we document that episodes of market turmoil in the European sovereign bond market are on average associated with large decreases in trading volume. The response of trading volume to market stress is conditional on transaction costs. Low transaction cost turmoil episodes are associated with volume increases (investors rebalance), while high transaction cost turmoil periods are associated with abnormally low volume (market freezes). We find suggestive evidence of market freezes in response to shocks to the risk bearing capacity of market makers while investor rebalancing is triggered by wealth shocks. Overall, our results show that the recent sovereign debt crisis was not associated with large-scale investor rebalancing.

Beyond spreads: Measuring sovereign market stress in the euro area

We develop a novel composite indicator to measure sovereign bond market stress in the euro area. The indicator integrates yield and liquidity spreads along with volatility into an overall measure of sovereign market stress. An application to the spillover literature suggests that stress mainly originates from a few countries, but that spillover patterns also vary over time.

Does the Brexit Referendum Affect the Integration between the UK and other European Countries? Evidence from the Sovereign Bond Market

This paper investigates the impacts of the Brexit referendum on equilibrium relationships and spillover effects between the UK and other European countries’ sovereign bond markets. We run vector error correction model (VECM) with dummy variables to detect the shifts in the long-run equilibriums and short-run error correction mechanisms around the Brexit referendum. We then use spillover analysis proposed by Diebold and Yilmaz (2009) to examine static and dynamic spillover effects between the UK and the (non-) Eurozone. The empirical results suggest that there exists significant shift in the integration between the UK and other EU countries’ sovereign bond markets during different periods. Moreover, the integration and spillover effects became stronger after the Brexit referendum on 23 June 2016.

On the exposure of insurance companies to sovereign risk—Portfolio investments and market forces

A sovereign debt crisis can have significant knock-on effects in the financial markets and put financial stability at risk. This paper focuses on the transmission of sovereign risk to insurance companies as some of the largest institutional investors in the sovereign bond market. We use a firm level panel dataset that covers large insurance companies, banks and non-financial firms from nine countries over the time period from 1 January 2008–1 May 2013. We find significant and robust transmission effects from sovereign risk to domestic insurers. The impact on insurers is not significantly different from that on banks but larger than for non-financial firms. We find that systemically important insurers are more closely linked to the domestic sovereign. Based on European data, we show that risks in sovereign bond portfolios are an important driver of insurer risk, which is not reflected in current insurance regulation (incl. Solvency II in Europe).

Do domestic bond markets participation help reduce financial dollarization in developing countries?

In this paper, I analyze the effect of domestic sovereign bond market (BM) participation on financial dollarization using a large panel of 114 developing countries over the period 1984–2009. Building on entropy balancing, my results reveal strong evidence that domestic BM participation significantly reduces financial dollarization in domestic BM countries compared to their non-domestic BM peers. Moreover, I find that the favorable impact of domestic BM on financial dollarization (i) is larger for inflation targeting countries compared to non-inflation targeting countries, (ii) is apparent exclusively in a non-pegged exchange rate regime, (iii) and is larger when there are fiscal rules that constrain the discretion of fiscal policy makers. Finally, I show that the induced drop in inflation rate and its variability, nominal exchange rate variability, and seigniorage revenue are potential transmission mechanisms through which the presence of domestic BM reduces financial dollarization in domestic BM countries.

Alpha-CIR Model with Branching Processes in Sovereign Interest Rate Modelling

We introduce a class of interest rate models, called the α-CIR model, which gives a natural extension of the standard CIR model by adopting the α-stable Levy process and preserving the branching property. This model allows to describe in a unified and parsimonious way several recent observations on the sovereign bond market such as the persistency of low interest rate together with the presence of large jumps at local extent. We emphasize on a general integral representation of the model by using random fields, with which we establish the link to the CBI processes and the affine models. Finally we analyze the jump behaviors and in particular the large jumps, and we provide numerical illustrations.

Europe needs more than a Capital Markets Union—focus on the integration of euro area sovereign debt markets

Mit dem Ziel einer Kapitalmarktunion sind Bestrebungen im Gange, (private) Kapitalmärkte zu integrieren sowie private Risiken in der Europäischen Union zu teilen. Zu beachten ist, dass der Binnen(kapital)markt durch eine latente Instabilität der Staatsanleihenmärkte im Euroraum bedroht ist, zumal diese Märkte sich während der "Euro-Krise„ desintegriert hatten. Zwar wurden Reformen der institutionellen Architektur des Euro-Währungsgebiets, wie etwa große Teile der Bankenunion, erfolgreich umgesetzt; jedoch sind jene Aspekte des Euroraums, die Fragmentierung und Flucht nach Sicherheit bewirken, nicht hinlänglich repariert. Mit der Einführung der Gemeinschaftswährung wurden die Mitgliedstaaten zu „subsidiären Regierungen„, die keine Staatsanleihen mehr unter ihrer alleinigen "monetären Kontrolle„ emittieren können. Integration der Staatsanleihenmärkte im Euroraum sollte daher oberste Priorität erhalten. Eine Möglichkeit wäre, die Souveränität über Euro-Anleihen zu poolen. Alternativ dazu ließen sich, angesichts der Skepsis gegenüber einer Risikoteilung zwischen Mitgliedsstaaten, synthetische Euro-Anleihen einführen, die keine Vergemeinschaftung von Schulden mit sich bringen.

Athens by the Alps: How the Eurozone Bailouts Made Interest Rates History

The €215 billion lent to Greece by her Eurozone siblings are likely among the very cheapest funding ever enjoyed by a sovereign borrower. Not only would the effective net interest rate so far be negative, but actually more so than those faced by essentially all countries lucky enough to have been able to issue negatively-yielding debt of similar maturity. If, as data and reports seem to confirm, the period of negative yields witnessed in the sovereign bond market in the past couple of years would constitute a historical outlier and aberration then the effective rate that the Eurozone did afford and wanted to afford Greece would indeed be one of the very lowest (if not the lowest) in History. Only Switzerland may have a claim to a more negative similarly-dated funding. The main purpose of this brief analysis is to illustrate how incredibly generous the bailout loans granted to Greece have been, not just in nominal terms or in the current context but crucially also from a historical perspective.

Solving the pari passu puzzle: the market still knows best

As a result of the Argentine sovereign debt crisis and ensuing holdout litigation saga, the pari passu (or ranking) clause became a source of great consternation in the international sovereign bond market. Specifically, Judge Griesa’s holding that Argentina had violated the pari passu clause by refusing to pay creditors who had not participated in the nation’s earlier debt exchanges, and accompanying requirement that Argentina had to pay those holdout bondholders, led to uncertainty in the market regarding the leverage holdouts could exercise in sovereign debt restructurings going forward. Concern was expressed over the ability of sovereigns to succeed with voluntary exchange offers premised on the threat that the restructuring sovereign would default on payments due to non-participating bondholders. This article evaluates the impact of the court’s decision in the Argentine litigation to date and discusses the adoption of improved ranking clauses and collective action voting clauses in recent issuances of sovereign debt in the effort to bring greater certainty to market participants and facilitate efficient restructurings in the future without the need for extra-contractual restructuring mechanisms and remedies.

Oil price shocks and volatility spillovers in the Nigerian sovereign bond market

This paper investigates volatility spillover in the Nigerian sovereign bond market arising from oil price shocks, using Vector Autoregressive Moving Average - Asymmetric Generalized Autoregressive Conditional Heteroscedasticity (VARMA-AGARCH) model. The paper covers the period March 22, 2011 to April 14, 2016 and makes use of the daily data of the Nigerian Sovereign Bond, Brent oil and West Texas Intermediate (WTI), respectively. We endogenously and sequentially detect structural break points using the test of Bai and Perron (2003) framework. In order to accurately estimate the model, we modify it by incorporating the break points into the VARMA-AGARCH model, a process which if ignored would lead to model misspecification. The results obtained demonstrate a significant cross-market volatility transmission between oil and sovereign bond market with ample sensitivity to structural breaks. The study also computes optimum weight portfolio and hedge ratio both with and without structural breaks and results equally indicate sensitivity to structural breaks.

The national segmentation of euro area bank balance sheets during the financial crisis

This paper analyses bank balance sheet data in conjunction with macroeconomic and other financial variables. Our aim is to understand the nature of the instability in financial intermediation in the euro area during the recent financial crises. We define “large changes” as significant departures in the actual evolution of balance sheet variables during the crisis from their historical association with the business and financial cycles. In the course of the global 2008–2009 financial crisis, such “large changes” were features of the behaviour of cross-border inter-bank flows, both within the euro area and between the euro area and the rest of the world. By contrast, retail assets and liabilities, as well as inter-bank flows among banks of the same country, did not significantly deviate from historical regularities. Since the euro area sovereign crisis of 2011–2012, “large changes” have been more pervasive. In particular, a significant home bias in the sovereign bond market has emerged.