Sovereign Yield Research Articles

Factors of the term structure of sovereign yield spreads

We investigate the term structure of sovereign yield spreads for five advanced economies against the US and provide novel insights on the key drivers of the term structure. We show that the spread term structure dynamics are driven by three latent factors which can be labeled as spread level, slope and curvature similar to common interpretations found in the yield curve literature. We further show that these estimated spread factors have predictive power for exchange rate movements and excess returns, above the predictability of an uncovered interest rate parity approach. As the yield curve contains information about expected future economic conditions we conjecture that these yield spread factors reflect expected macroeconomic differentials which in turn drive exchange rates. Using the information content of yield spread curves may thus be a promising approach to improve the forecasting accuracy of exchange rate models.

The Sovereign Yield Curve and Credit Ratings in GIIPS

This paper studies the impact of sovereign credit rating and outlook changes on the shape of sovereign yield curve. The data sample consists of five peripheral European countries known as GIIPS (Greece, Ireland, Italy, Portugal and Spain) over the period of 01 January 2001 to 30 June 2016. We use dynamic Nelson-Siegel model to estimate the level, slope and curvature of yield curve and subsequently, Vector Autoregressive model to estimate the effect of sovereign rating and outlook changes on the sovereign yield curve. We find significant effect of rating downgrades and insignificant effect of rating upgrades in all the five countries; however, find mixed results for the effect of changes in outlook status. We find some peculiarity in the behavior of Portuguese yield curve that is explainable under preferred habitat theory. A battery of sensitivity tests also validates the results.

Why Are Banks Not Recapitalized During Crises?

I develop a model where the sovereign debt capacity depends on the capitalization of domestic banks. Low-capital banks optimally tilt their government bond portfolio toward domestic securities, linking their destiny to that of the sovereign. If the sovereign risk is sufficiently high, low-capital banks reduce private lending to further increase their holdings of domestic government bonds, lowering sovereign yields and supporting the home sovereign debt capacity. The model rationalizes, in the context of the eurozone periphery, the increase in domestic government bond holdings, the reduction of bank credit supply, and the prolonged fragility of the financial sector.

Why Are Banks Not Recapitalized During Crises? A Political Economy Explanation

I develop a model where the sovereign debt capacity depends on the capitalization of domestic banks. Low-capital banks optimally tilt their government bond portfolio toward domestic securities, linking their destiny to that of the sovereign. If the sovereign risk is sufficiently high, low-capital banks reduce private lending to further increase their holdings of domestic government bonds, lowering sovereign yields and supporting the home sovereign debt capacity. The model rationalizes, in the context of the eurozone periphery, the increase in domestic government bond holdings, the reduction of bank credit supply, and the prolonged fragility of the financial sector.

On the Extreme Correlation between Sovereign Yield Spread and Bank Stock Returns: Evidence from Italy

We analyze the interdependence between the government yield spread and stock returns of the banking sector in Italy during the years 2003-2015. In a first step, we find that after September 2008 the Spearman's rank correlation between the yield spread and the Italian banking system changed significantly. According to this finding, we split the time window in two subperiods. While we show that the dependence between the banking industry and changes in the yield spread increased significantly in the second time interval, we find no contagion effects from changes in the yield spread to returns of the banking system.

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 in the data occurs since the beginning of 2012. We fit the model by Quasi-Maximum Likelihood and highlight three important consequences of sovereign spreads’ nonlinear behavior: i) their distribution is skewed, ii) they are affected by (possibly exogenous) changes in the lower bound, and iii) they become less informative about the countries’ sovereign risk. Shadow spreads, however, still provide reliable information.

Spillovers Among Sovereign Debt Markets: Identification by Absolute Magnitude Restrictions

This paper studies spillovers among US and European sovereign yields. We provide a new method based on absolute magnitude restrictions of the impact matrix to identify the countries that were the main sources of spillovers. Despite the large size of shocks from euro area stressed countries, connectedness among sovereign yields declined between 2008 and 2012 due to financial fragmentation, particularly between countries with more divergent business and fiscal cycles. We show that none of the sovereign yields are insulated from foreign shocks and that shocks to the Greek bond market in 2010 explained 20-30% of the variance of sovereign yields in stressed countries, while in 2011-2012 Italy (not Spain) was the source of systemic risk.

Realized (co)variances of eurozone sovereign yields during the crisis: The impact of news and the Securities Markets Programme

We use realized variances and covariances based on intraday data to measure the dependence structure of eurozone sovereign yields. Our analysis focuses on the impact of news, obtained from the Eurointelligence newsflash, on the dependence structure. More news tends to raise the volatility of yields of financially-distressed countries and to decrease the covariance of distressed countries’ yields with German bond yields, suggesting a potential flight-to-quality effect. Common news about the euro crisis and news about specific countries tend to raise the covariance of yields between distressed countries, indicating potential crisis spill-over effects. However, we do not detect spillover effects from news about third countries to the covariance between other country pairs. Bond purchases by the ECB under its Securities Markets Programme (SMP) mitigate the negative crisis spillovers among the distressed countries and reduce the potential flight-to-quality from the distressed countries to Germany.

Debt crisis and 10-year sovereign yields in Ireland and in Portugal

ABSTRACTWe assess the determinants of the 10-year sovereign yield for the period 2000–2015, in Portugal and in Ireland. Results show that the long-term Portuguese sovereign yield increased with the rise of the 10-year Bund yield and during the Securities Markets Programme, but decreased due to financial integration. Additionally, during the period of the economic and financial adjustment programme, there was evidence of additional rises (decreases) due to increases (decreases) in the 3-month Euribor rate, and the level of public debt. EU/IMF funding reduced sovereign yield.

Yields on Sovereign Debt, Fragmentation and Monetary Policy Transmission in the Euro Area: A GVAR Approach

The divergence in sovereign yields has been presented as a reason for the lack of traction of monetary policy. We use a GVAR framework to assess the transmission of monetary policy in the period 2005-2016. We identify sovereign yield divergence as a key mechanism by which the leverage channel of monetary policy worked. Unconventional monetary policy was successful in mitigating this effect. When exploring the channels through which yields may affect the heterogeneous transmission of monetary policy, we find that the reaction of bank leverage depended substantially on where the sovereign yield originated, thus providing a mechanism that explains this heterogeneity. Second, large spillover effects meant that yield divergence decreased the traction of monetary policy even in anchor countries. Third, the heterogeneity in the transmission mechanism can be in part attributed to contagion from euro-area wide sovereign stress. Fiscal credibility, therefore, may be an appropriate tool to enhance the output effect of monetary policy. Given the importance of spillovers, this credibility may be achieved by changes in the institutional make-up and policies in the euro area.

Excessive Debt or Excess Savings -- Transition Countries Sovereign Bond Spread Assessment

We study the sovereign yield spreads determinants in transition – Central and Eastern Europe (CEE) and Caucasus and Central Asia (CCA) -- countries and try to provide an answer to the key question: was the narrowing of the spreads and their compression a result of improvement of CEECCA countries sovereign’s macroeconomic policy (implemented in early to mid 2000s), or was it due to global excess liquidity provision? If better domestic macroeconomic policy efforts and solid reforms implemented in this period have led to: i) improvement in sovereign debt management e.g., by increasing the average debt portfolio duration and reducing the stock of FOREX debt; ii) development of domestic financial markets with enlargement of the investor’s base and enhancement of the risk management techniques; iii) continuing financial liberalization; iv) sustainable fiscal adjustment, reserve accumulation and price stability; and v) adoption of the most conductive to prosperity institutional structure, then it would be expected that any tighter monetary policy environment in the developed economies should have only a tiny effect on spreads.The models are estimated on an individual basis -- country by country -- using a framework allowing for fractionally integrated variables (ARDL) as well as, by utilising panel data (cross-sectional-time-series) estimation whenever data availability allows.We utilise daily data over the period 2006-2012 and quarterly data over the period 2002-2011. These are the periods for which meaningful comparable data are available for Bulgaria, Croatia, Hungary, Kazakhstan, Poland, Russia, Serbia, and Ukraine (in various combinations).We are careful not to attempt to split the sample into (say two) potential segments for comparison of “normal” versus “crises” period estimates (as customary) as since 2002 / 2003 the transition economies have started to experience the powerful financial effect generated by the excess global liquidity, i.e., the entire period under consideration is constituted by two phases characterised by: i) excess liquidity (2002-2008); and, ii) the Great Depression Mark II (2008 – to present).

Implicit Public Debt Thresholds: An Empirical Exercise for the Case of Spain

We extend previous work that combines the Value at Risk approach with estimation of the correlation pattern of the macroeconomic determinants of public debt dynamics by means of Vector Auto Regressions (VARs). These estimated models are used to compute the probability that the public debt ratio exceeds a given threshold, by means of Monte Carlo simulations. We apply this methodology to Spanish data and compute time-series probabilities to analyse the possible correlation with market risk assessment, measured by the spread over the German bond. Taking into account the high correlation between the probability of crossing a pre-specified debt threshold and the spread, we go a step further and ask what would be the threshold that maximises the correlation between the two variables. The aim of this exercise is to gauge the implicit debt threshold or «prudent debt level» that is most consistent with market expectations as measured by the sovereign yield spread. The level thus obtained is consistent with the medium-term debt-to-GDP ratio anchor of 60% of GDP.

Flow Effects of Central Bank Asset Purchases on Euro Area Sovereign Bond Yields: Evidence from a Natural Experiment

We estimate the response of euro area sovereign bond yields to purchase operations under the ECBs Public Sector Purchase Programme (PSPP), using granular data on all PSPP-eligible securities at daily frequency. To avoid simultaneity bias in the estimated relationship between yields and purchase volumes, we exploit a PSPP design feature that renders certain securities temporarily ineligible for reasons unrelated to their yields. Using these temporary purchase restrictions as an instrument to identify exogenous variation in purchase volumes, we find that the “flow effect” of PSPP operations has, on average, led to a temporary 7 basis-point decline in sovereign bond yields on the day of purchase. This impact estimate is well above those found in similar studies for the US; at the same time, our results imply that flow effects have accounted for only a limited share of the downward pressure of PSPP on sovereign yields, most of which instead derived from anticipation and announcement effects at the onset of the programme. JEL Classification: E52, E58, E65, G12

Euro Area Sovereign Yields and the Power of QE

We assess the determinants of long-term sovereign yield spreads using a panel of 10 Euro area countries over the period 1999.01–2016.07 notably regarding the ECB (standard and non-standard) quantitative easing measures. Our findings indicate that the international risk, the bid-ask spread and real effective exchange rate increased the 10-year sovereign bond yield spreads. Moreover, quantitative easing, notably Longer-term Refinancing Operations (LTROs), Targeted LTROs and the Securities Market Program decreased the yield spreads.

Why are Banks Not Recapitalized During Crises?

I develop a model where governments might prefer to have an undercapitalized domestic financial sector during crises. Weak banks optimally tilt their sovereign bond portfolio towards domestic securities that are positively correlated with banks’ other sources of revenues. Governments anticipate this gambling-forresurrection motive and therefore face a trade-off when setting capital regulation. Undercapitalized banks act as buyers of last resort for home public debt at the cost of crowding-out private lending. Following recapitalizations, governments may face lower debt capacity and higher sovereign yields. European stress test data support the proposed mechanism as high leverage banks increased domestic government bond holdings relative to low leverage banks during the crisis. The general equilibrium model can rationalize, in the context of the Eurozone periphery, the increased banks’ holdings of domestic public debt, the ecreasing private lending, and the prolonged undercapitalization of the banking sector.

The role of uncertainty in the euro crisis – an application of liquidity preference theory

The world financial crisis triggered a rediscovery of the active role fiscal policy can play as a remedy in such situations. During the euro crisis, escalating funding costs in a number of southern eurozone member states and Ireland have called this strategy into question. One interpretation of the euro crisis concentrated on the public debt trends in those countries. Opposing this view, the main point of this contribution is to elaborate the link between rising interest rates on sovereign bonds in the euro crisis and a major feature of the financial crisis – a subdued degree of investor confidence after the Lehman collapse. Theoretically, this link is developed with reference to Keynes’ liquidity preference theory. The high explanatory power of measures for the degree of confidence in financial markets as well as detrimental effects of fiscal austerity on the evolution of sovereign yield spreads are demonstrated empirically by means of panel regressions and supplementary correlation analyses.

State-varying illiquidity risk in sovereign bond spreads

Illiquidity and default risk are determinants of bond spreads that models suggest vary across market states. The Australian sovereign debt market, where the Australian government provided an explicit guarantee over semi-government debt, provides an environment in which to examine these separate factors. We find little evidence that the factors proposed by reduced-form models can explain sovereign spreads, while, consistent with flights to liquidity, illiquidity risk is relevant particularly important during periods of market stress. These flights to liquidity are substantially more prominent at the shorter end of the term structure, whereas volatility predominantly explains longer-maturity sovereign spreads. The term spread of sovereign yields is shown to be negatively related to illiquidity during periods of stress, indicating that theoretical models that incorporate flights to liquidity need to be expanded to include the impact of such flights on both the level and slope of yields.

The Price Relevance of Fiscal Developments

ABSTRACTWe use Seemingly Unrelated Regressions Estimation methods to assess the link between prices, bond yields and the fiscal behavior. A first equation determines the country-specific cost of government financing via the long-term government bond yield, as a function of budget balance positions. A second equation links the price level to the cost of government financing. Our results for 15 EU countries in the period 1980Q1–2013Q4 show that improvements in the fiscal stance lead to persistent falls in sovereign yields; higher sovereign yields are reflected in upward price movements; improvements in the fiscal stance in recession times lead to short-term decreases in yields and better fiscal stance in expansions induce downward movement in bond yields only after 8 quarters.

Calibración de parámetros de los modelos de tasas de interés NS y NSS para Colombia: una nota técnica

Calibration of the Nelson-Siegel (NS) model to adjust to sovereign yield curves has been found to be problematic since the model exhibits a correlation between its factors, and generates objective functions with local multiple optima. These problems are often disregarded in the Colombian market, enough importance is not being given to the calibration process. This study aims to evaluate two non-gradient based methods for solving the non-linear least squares problem: the differential evolution metaheuristic and an incremental search procedure on the non-linear parameters. Comparisons of the results are made in terms of the achieved fit, consistency (for the metaheuristic) and the shapes obtained for the curves. The same procedure is carried out on the Nelson-Siegel-Svensson (NSS) model, evaluating the advisability of its use in the local market.

Animal Spirits vs Contagion: Which One is the Main Driver of Sovereign Yields in Europe?

The objective of this paper is to assess the differences between contagion and investors’ risk aversion in terms of their impact on European sovereign bond yields during the financial crisis. This paper evaluates contagion at banking level, as it has the advantage of capturing the exposure of sovereign debt markets to financial sector’s risk and also the contagion between sovereign spreads that occurs through the financial sector channel. The paper analyzes the period from 2008 to 2012 and also the Greek, Portuguese and Spanish bailout periods. The results indicate that the main driver of yields in Europe is risk aversion and not contagion. The main differences between Central and Southern European countries’ yields are explained by risk aversion. This channel has a much stronger impact on the periphery. On the other hand, contagion exerts a similar influence throughout all European countries. JEL codes: