Sovereign Bond Yields Research Articles

Heterogeneity of the determinants of Euro-area sovereign bond spreads: what does it tell us about financial stability?

In this paper we assess the movements of euro area sovereign bond yield spreads vis-a-vis the German Bund as processes specified across different levels of volatility and subject to movements in asset prices and economic conditions. The determinants we use are grouped into domestic and euro-area aggregates, thus allowing us to derive results on their relative explanatory power for movements in spreads and compare them across time and the spectrum of countries. We find that volatility influences the deterministic processes of the euro area sovereign spreads and that identical determinants have effects on spreads that vary considerably across countries. Furthermore, we find that economic sentiment indices are the most important determinants and their significance remains, to a large extent, even when controlling for the debt-to-GDP ratio.

A Dynamic Approach to Interest Rate Convergence in Selected Euro-Candidate Countries

Diese Studie befurwortet einen dynamischen Ansatz zur Analyse montarer Konvergenzprozesse der EuroKandidatenlander. Der dynamische Ansatz basiert auf der Analyse der Stabilitat der Finanzsysteme. Wir testen die Volatilitatsdynamik der Risikoaufschlage auf die langfristigen Zinssatze fur funf der im Mai 2004 der EU beigetretenen Lander, wobei die Risikopramie durch die Differenz zwischen dem EUDurchschnitt und den neuen Mitgliedslandern bei den durchschnittlichen Renditen auf langfristige Staatspapiere wiedergegeben wird. Die taglichen Daten bilden den Zeitraum vom 2. Januar 2001 bis zum 22. Januar 2009 ab. Es zeigen sich durchaus unterschiedliche Kopplungen in den Bewegungen der Renditen; die starkste Kopplung besteht fur die Tschechien, Slowenien und Polen, eine schwachere fur Ungarn und die Slowakei. Seit ihrem EUBeitritt zeichnet sich allerdings auch eine Divergenz zwischen den Renditen der funf Lander und dem EuroDurchschnitt ab. Daraus schliesen wir, dass eine statische Definition des MaastrichtKriteriums fur Renditen auf langfristige Staatspapiere nicht ausreichend ist, um Fortschritte in der Stabilitat der Finanzsysteme der EuroKandidatenlander zu diagnostizieren.

Trust no more? The impact of the crisis on citizens’ trust in central banks

Citizens’ trust in economic institutions has generally declined since the onset of the crisis. In particular, Eurobarometer surveys show that trust in the European Central Bank (ECB) has fallen significantly during the crisis. This paper studies the determinants of public trust in the ECB over the lifetime of the euro. Net trust in the ECB has decreased significantly in those countries which have experienced increasing sovereign bond yields and financial market turbulence. The finding that country-specific variables affect citizens’ trust in the ECB may seem counterintuitive. However, it is consistent with strong evidence in the political science literature showing that domestic considerations play a significant role when citizens get an opportunity to express their opinion on EU matters.

Sovereign Bond Yield Spreads: A Time-Varying Coefficient Approach

We study the determinants of sovereign bond yield spreads across 10 EMU countries between Q1/1999 and Q1/2010. We apply a semiparametric time-varying coefficient model to identify, to what extent an observed change in the yield spread is due to a shift in macroeconomic fundamentals or due to altering risk pricing. We find that at the beginning of EMU, the government debt level and the general investors' risk aversion had a significant impact on interest differentials. In the subsequent years, however, financial markets paid less attention to the fiscal position of a country and the safe haven status of Germany diminished in importance. By the end of 2006, two years before the fall of Lehman Brothers, financial markets began to grant Germany safe haven status again. One year later, when financial turmoil began, the market reaction to fiscal loosening increased considerably. The altering in risk pricing over time period confirms the need of time-varying coefficient models in this context.

Sovereign bond yield spreads: A time-varying coefficient approach

We study the determinants of sovereign bond yield spreads across 10 EMU countries between Q1/1999 and Q1/2010. We apply a semiparametric time-varying coefficient model to identify, to what extent an observed change in the yield spread is due to a shift in macroeconomic fundamentals or due to altering risk pricing. We find that at the beginning of EMU, the government debt level and the general investors’ risk aversion had a significant impact on interest differentials. In the subsequent years, however, financial markets paid less attention to the fiscal position of a country and the safe haven status of Germany diminished in importance. By the end of 2006, two years before the fall of Lehman Brothers, financial markets began to grant Germany safe haven status again. One year later, when financial turmoil began, the market reaction to fiscal loosening increased considerably. The altering in risk pricing over time period confirms the need of time-varying coefficient models in this context.

Are Sovereign Bond Yield Spreads Affected by Investor Sentiment? Evidence from the Greek Budget Crisis

This paper examines the determinants of the Greek yield spread and finds that a significant determinant for both the level and the changes in the spread, along with local economic activity, is local and international investor sentiment, especially during the crisis period.

The Race to the Bund: Aggregate European and State-Level Integration from the EEC to Present

Many scholars point to the decreasing yield spread between the benchmark German bund and other European states as a sign of unprecedented European integration since Maastricht. There are two possible issues with this claim. First, without a historical perspective on sovereign bond yields and their comovements, researchers cannot determine how current levels of integration compare to previous periods of European history. To my knowledge, no previous research examines European yields from the formation of the ECSC or EEC to present, let alone pre-war spreads. Second, the first two moments of yield spreads do not necessarily capture meaningful integration. While the spreads are certainly an important measure, we can better assess integration by examining the correlation of these yields. In this article, I address both of these issues as follows. First, I describe an alternative method of measuring integration in the sovereign bond market based on an eigendecomposition of the time-dependent correlation of yields and their first-order differences. This approach better measures integration than standard methods because it takes into account the degree to which a single dimension explains the structure and movement of yields. Second, I construct a dataset of ten-year sovereign bond yields for the EU-15 countries from 1987 to 2010, as well as subsets of these 15 countries from 1958-2010 and from 1872-1913. I then apply both standard yield spread analysis and the method proposed in this article to these three samples. The results of the standard yield spread analysis indicate that Europe has seen previous periods of comparable financial integration. However, based on the alternative method of this article, integration did not occur until the Single European Act of 1987 and the Maastricht Treaty of 1993. A period of stable and high integration is observed following the adoption of the Euro in 1999. Furthermore, both methods show that the recent global real estate and European fiscal crises have significantly degraded financial integration to a level not seen since Maastricht. In summary, this article contributes both a novel and useful methodological approach and a historical basis on which to evaluate modern European integration in the sovereign bond market.

Sovereign Spreads and Contagion Risks in Asia

This paper explores how much of the movements in the sovereign spreads of Asian economies over the course of the global financial crisis has reflected shifts in (i) global risk aversion; (ii) country-specific risks, directly from worsening fundamentals, and indirectly from spillovers originating in other sovereigns and the uncertainty surrounding exchange rates. Earlier in the crisis, the increase in market-implied contagion led to higher Asian sovereign bond yield spreads over swaps. But, after the crisis, Asia’s sovereign spreads normalized, despite the debt crisis in the euro area, reflecting a fall in both exchange rate and spillover risks.

What Explains the Surge in Euro Area Sovereign Spreads during the Financial Crisis of 2007–09?

This paper explains the determinants of widening sovereign bond yield spreads vis-à-vis Germany in selected euro area countries during the period end-July 2007 to end-March 2009, when the financial turmoil developed into a full-blown financial and economic crisis. Emphasis is given to the role of fiscal fundamentals and government announcements of substantial bank rescue packages. The paper finds that higher expected budget deficits and/or higher government debt ratios relative to Germany contributed to higher government bond yield spreads in the euro area during the analyzed period. More importantly, the announcements of bank rescue packages have led to a re-assessment, from the part of investors, of sovereign credit risk, first and foremost through a transfer of risk from the private financial sector to the government.

Zinsspreads auf europäische Staatsanleihen: Implikationen und Lehren aus der europäischen Schuldenkrise

This study analyses the time-varying determinants of sovereign bond yield spreads between Q1/1999 and Q1/2010. Before the financial crisis, which started end of 2007, financial markets seemed to have had limited assessment of credit risks in sovereign bond markets and risk aversion did not play a significant role in explaining bond yield spreads. After the outbreak of the financial crisis, markets corrected their previously too optimistic risk sensitiveness and started to consider the fiscal position of individual countries in their interest rate setting again. It is shown that the interest rate that Greece paid on its debt was, for a long time, too low when compared to other European countries. It was at the end of 2009 that the Greek interest rate advantage vanished. Given the fact that the Stability and Growth Pact (SGP) in its current form turned out to be ineffective in the past, one can conclude that financial markets play a very important role in imposing fiscal discipline on governments. The introduction of European bonds ('e-bonds') would work against this disciplining effect. A more sustainable solution to solve the problem of high and volatile risk premia on sovereign bonds without setting the stability of the whole euro area at risk is the introduction of a rule-based European crisis mechanism, which guides the handling of sovereign defaults, and the return to a credible fiscal consolidation path of all member states.

Dynamic Linkages among Major Sovereign Bond Yields

This article investigates the dynamic linkages among four major sovereign bond yields (German, Japanese, U.K., and U.S.) for the 1990–2010 period. Using VAR analysis and Engle’s dynamic conditional correlation GARCH specification, the author examines the short- and long-run linkages between yield pairs and finds that yield correlations are time-varying and differ during economic expansions and contractions. Finally, the author assesses the impact of bond yield correlations on the other bond yields’ dynamic correlations and report that the U.S. bond yield volatility affects the other yields’ correlations differently. The results have significant implications for bond portfolio construction and monetary policymaking.

Fiscal Deficits, Public Debt, and Sovereign Bond Yields

The recent sharp increase in fiscal deficits and government debt in many countries raises questions regarding their impact on long-term sovereign bond yields. While economic theory suggests that this impact is likely to be adverse, empirical results have been less clear cut, have generally ignored nonlinear effects of deficits and debt through some other key determinants of yields, and have been mostly confined to advanced economies. This paper reexamines the impact of fiscal deficits and public debt on long-term interest rates during 1980 - 2008, taking into account a wide range of country-specific factors, for a panel of 31 advanced and emerging market economies. It finds that higher deficits and public debt lead to a significant increase in long-term interest rates, with the precise magnitude dependent on initial fiscal, institutional and other structural conditions, as well as spillovers from global financial markets. Taking into account these factors suggests that large fiscal deficits and public debts are likely to put substantial upward pressures on sovereign bond yields in many advanced economies over the medium term.

Fiscal Deficits, Public Debt, and Sovereign Bond Yields

Fiscal Deficits, Public Debt, and Sovereign Bond Yields

Short and Long-Run Behaviour of Long-Term Sovereign Bond Yields

This study assesses the short and long-run behaviour of long-term sovereign bond yields in OECD countries, for the period 1973-2008. We employ a dynamic panel approach to reflect financial and economic integration, and to increase the performance and accuracy of the tests. Given the existence of cross-country dependence regarding sovereign yields and its determinants, we resort to simulation and bootstrap methods for the analysis. Results based on the Common Correlated Effect estimator of Pesaran (2006) and on Panel Error Correction Models to sort out short- and long-run fiscal developments show that in addition to common movements in sovereign yields, investors also consider country differences arising from specific factors (inflation, budgetary and current account imbalances, real effective exchange rates, and liquidity).

European Sovereign Bond Spreads: Monetary Unification, Market Conditions and Financial Integration

In this paper we examine the dynamics of European sovereign bond yield spreads focusing on issues related to financial integration and market conditions. The finding of near-unit-root effects highlights the need for careful econometric specification. Thus we formulate sovereign bond yield spreads, for eleven EMU countries against the Bund for the period 1992:1-2009:12, as AR(1) processes, while allowing for regime switching effects, along the lines of a Markovian probabilistic specification. Specifically, by taking into account regime switching effects we examine, rather than assume, that monetary unification affected sovereign bond yield spreads, allowing for states of higher and lower interactions to be revealed. Next, we examine the effects of several exogenous explanatory variables. Our results indicate that European sovereign bonds achieved only partial integration even before the recent financial crisis, while financial integration and financial stability are found to be interconnected. Specifically, we find evidence of different effects exercised by the same deterministic factors on sovereign bond yield spreads even before the recent crisis. Additionally, it appears that a negative relation exists between low-volatility conditions and the magnitude of effects exercised by idiosyncratic risk factors on bond yield spreads.

Mind the Gap: Disentangling Credit and Liquidity in Risk Spreads

Wide and volatile interest rate spreads in the 2007-2009 financial crisis could represent concerns over asset liquidity or issuer solvency. To precisely identify the contribution of these two effects on sovereign bond and interbank spreads, I propose a model-free measure of euro-area market liquidity, and a measure of near-term interbank default risk. I find that credit and liquidity are independently important. In interbank risk spreads, the role of liquidity dominates, while the importance in sovereign bond yield spreads varies substantially by country and maturity. To better understand the liquidity channel that is captured by the new liquidity measure, but is understated by extant measures, I test the pricing of liquidity risk; the possibility that liquidity could be negatively correlated with marginal utility. I exploit the variation in returns over countries, maturities and time, and find that liquidity euro-area sovereign bond risk premia are large and significant.

AN ADMISSIBLE TERM STRUCTURE MODEL OF SOVEREIGN YIELD SPREADS WITH MACRO FACTORS: THE CASE OF BRAZILIAN GLOBAL BONDS

We study the term structure of Brazilian sovereign bond yield spreads and their links with the domestic economy using a macro‐finance framework. Our model allows Brazilian macroeconomic variables as well as a latent country risk factor to affect sovereign spreads. We find that although the Brazilian sovereign yield spreads are dominated by the risk factor during the high default risk periods of 1999 and 2002, the effects of macro variables are significant during the rest of the estimation period. In addition, the volatility level of the macroeconomic system is driven by the country risk factor.

What Explains the Surge in Euro Area Sovereign Spreads During the Financial Crisis of 2007-09?

This paper uses a dynamic panel approach to explain the determinants of widening sovereign bond yield spreads vis-a-vis Germany in selected euro area countries during the period end-July 2007 to end-March 2009, when the financial turmoil developed into a full-blown financial and economic crisis. Emphasis is given to the role of fiscal fundamentals and government announcements of substantial bank rescue packages. The paper finds that higher expected budget deficits and/or higher government debt ratios relative to Germany contributed to higher government bond yield spreads in the euro area during the analysed period. More importantly, the announcements of bank rescue packages have led to a re-assessment, from the part of investors, of sovereign credit risk, first and foremost through a transfer of risk from the private financial sector to the government.

Modelling sovereign bond yield curves of the US, Japan and Germany

AbstractThe movement of sovereign yields is important for both investment and risk management. This paper applies a method that was first developed by Diebold et al. (2006) to model the sovereign bond yield curves of the US, Japan and Germany. By including observable macroeconomic variables as well as the latent factors of the yield curve, we find evidence of a strong interaction between the yield curve and macro‐variables in the US and Germany but not in Japan. We also estimate the dynamic conditional correlations of the latent factors to reveal the cross‐country correlations of the bond markets. Copyright © 2007 John Wiley & Sons, Ltd.

Do Economists' and Financial Markets' Perspectives on the New Members of the EU Differ?

In the past several years, the ten new Central and Eastern European members of the European Union have enjoyed rapid growth but frequently alongside growing external imbalances. Economists have pointed to rising vulnerabilities, but markets compressed sovereign bond yields. This paper examines the evidence from the perspective of economists' vulnerability analysis and markets' pricing of sovereign bonds. It finds that spread are lower than can be explained by fundamentals and speculates on the causes and permanence of this yield compression.