Euro Area Sovereign Risk During the Crisis

Abstract

This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate.While the use of public resources is critical to cushion the impact of the financial crisis on the euro-area economy, it is key that the entailed fiscal costs not be seen by markets as undermining fiscal sustainability. From this perspective, to what extent do movements in euro area sovereign spreads reflect country-specific solvency concerns? In line with previous studies, the paper suggests that euro area sovereign risk premium differentials tend to comove over time and are mainly driven by a common time-varying factor, mimicking global risk repricing. Since October 2008, however, there is evidence that markets have become progressively more concerned about the potential fiscal implications of national financial sectors' frailty and future debt dynamics. The liquidity of sovereign bond markets still seems to play a significant (albeit fairly limited) role in explaining changes in euro area spreads. JEL Classification Numbers: E43, E62, G12.

An update on EMU sovereign yield spread drivers in times of crisis: A panel data analysis

“…Therefore, these results are in line with previous studies that point out the dynamic properties of sovereign spreads drivers over time after the start of the crisis [see, e.g., Pozzi and Wolswijk (2008), Gerlach et al (2010), Aβmann and Boysen-Hogrefe (2012) and Bernoth and Erdogan (2012)] or which show an increase in the sensitivity of the price of risk to fundamentals during the euro area debt crisis compared with the pre-crisis period (see Beirne and Fratzscher, 2013, among them). Not only do all the variables that capture both local and regional fundamentals or market sentiment increase their significance in the two groups of countries in the crisis period compared to the pre-crisis one, but the variable that gauges global market sentiment also increases its significance after the start of the crisis in both central and peripheral EMU countries, confirming the increased importance of investors' risk aversion suggested by the literature [see Codogno et al (2003), Sgherri and Zoli (2009) To further investigate the possibility of differences in spread behaviour before and after the crisis period, we once again apply the general-to-specific approach, commencing from a general congruent specification that is simplified to a minimal representation consistent with the data evidence. The general-to-specific reduction process ensures that the final and reduced model conveys all the information embodied in the unrestricted and general one, and opens up the possibility of identifying different explanatory variables for the different subsamples we are examining (whole period, pre-crisis, and crisis period) in the diverse groups of countries (all countries, central, and peripheral countries), since it produces empirical models that are data-coherent.…”

The Impact of Textual Sentiment on Sovereign Bond Yield Spreads: Evidence from the Eurozone Crisis

“…Moreover, the importance of credit risk has increased to a greater extent than liquidity. Mody (2009), Sgherri andZoli (2009), andSchuknecht et al (2011) also find that sovereign credit risk appears to be the major driver of the changes in sovereign yield spreads in the crisis period. Mody (2009) No previous studies investigate the effects of textual sentiment on sovereign yield spreads.…”

“…Studies that find significant effects of credit risk include Codogno et al (2003), Heppke-Falk and Huefner (2004), Bernoth et al (2006), Gomez-Puig (2006), Faini (2006), Beber et al (2009), and Barbosa andCosta (2010), andSchwarz (2014). A number of papers, such as Geyer et al (2004), Bernoth et al (2006), Sgherri and Zoli (2009), Attinasi et al (2009), Barrios et al (2009), Haugh et al (2009, Manganelli andWolswijk (2009), andGerlach et al (2010) conclude that general risk aversion plays a significant role in driving sovereign bond yield spreads.…”

“…Similar to Sgherri and Zoli (2009), the proxy for liquidity (LIQ) used in this research is the market value of long-term sovereign bond. Specifically, it is the market value 6 (in US dollars) of the Bank of America Merrill Lynch (BOFA ML) Government 10+Y Bond Index (sub-indices for each country), stated as the difference against Germany.…”

Granger-causality in peripheral EMU public debt markets: A dynamic approach

“…Moreover, several studies show that sovereign bond yields are not only driven by country-specific risk factors but that they are also significantly affected by global risk factors (see Codogno et al (2003), Sgherri and Zoli (2009) Appendix 1 offers a summary of the explanatory variables used in the empirical analysis as well as the data sources.…”