Sovereign Bond Yield Spreads: A Time-Varying Coefficient Approach

Abstract

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. JEL Classification Codes: C14, E43, E62, G12, H62, H63

Determinants of sovereign yield spreads in the Eurozone: A Bayesian approach

“…Such an analysis is especially appealing since an interesting new literature emerges that is concerned with changes in the influence of explaining variables. A discussion of this literature can be found in Bernoth and Erdogan (2010), who contribute to this literature by applying a semi-parametric time-varying coefficient model. However, considering a precrisis subsample is also appropriate when discussing the relation to somewhat older papers, which rely on samples that end before the crisis started.…”

Sovereign bond yield spreads and market sentiment and expectations: Empirical evidence from Euro area countries

“…DeGrauwe and Ji (2012) andAizenman et al (2013) have considered the ratio of debt-to-total tax revenues as an alternative indicator of debt sustainability.3 As discussed inBernoth and Erdogan (2012), several empirical analyses on sovereign yield differentials(Codogno et al, 2003;Favero et al, 2010) use bid-ask spreads as a direct liquidity measure. In our analysis, due to lack of data, we cannot consider the bid-ask spread as an alternative liquidity proxy.…”

Cross-Border Asset Holdings and Comovements in Sovereign Bond Markets

“…Our study draws on two strands of literature. The previous literature on interest-rate convergence in the EMU area looks mainly at a certain point on the yield curve, especially long-term yields such as 10-year government bond yields (see e.g., Codogno et al, 2003;Manganelli and Wolswijk, 2009;Bernoth and Erdogan, 2012;Antonakakis and Vergos, 2013;Costantini et al, 2014). There are a few exceptions; Baele et al (2004) show that local yields with various maturities of all EMU member countries become more integrated with those of Germany and France in the period 1999-2003 than in 1995-1998.…”