IDEAS home Printed from https://ideas.repec.org/a/eee/eecrev/v56y2012i1p36-53.html
   My bibliography  Save this article

The time-varying integration of euro area government bond markets

Author

Listed:
  • Pozzi, Lorenzo
  • Wolswijk, Guido

Abstract

We derive a model in which a standard international capital asset pricing model (ICAPM) for government bonds is nested within an ICAPM with impediments to invest in the local government bond markets. Excess returns or risk premiums are then driven by a country-specific or idiosyncratic stochastic factor on top of the common factor which has a time-varying idiosyncratic impact on the premiums. With this model we investigate the financial integration of government bond markets over time through two channels. First, we allow for gradual convergence from the full ICAPM with impediments to the standard model through the vanishing of the idiosyncratic factors. Second, we allow for gradual equalization of the country-specific impacts of the common factor. State space methods are used to estimate the model with weekly government bond risk premiums for Belgium, France, Italy, Germany, and the Netherlands over the period 1995–2009. Our results suggest, first, that the idiosyncratic factors were almost eliminated by 2006 in all countries but Italy but then reappeared due to the financial crisis that started in 2007. Second, the country-specific exposures to the common international risk factor have converged across countries, with no setback during the crisis.

Suggested Citation

  • Pozzi, Lorenzo & Wolswijk, Guido, 2012. "The time-varying integration of euro area government bond markets," European Economic Review, Elsevier, vol. 56(1), pages 36-53.
    • Handle: RePEc:eee:eecrev:v:56:y:2012:i:1:p:36-53
    DOI: 10.1016/j.euroecorev.2011.05.006
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S0014292111000638
    Download Restriction: Full text for ScienceDirect subscribers only
    File URL: https://libkey.io/10.1016/j.euroecorev.2011.05.006?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Ilmanen, Antti, 1995. "Time-Varying Expected Returns in International Bond Markets," Journal of Finance, American Finance Association, vol. 50(2), pages 481-506, June.
    2. von Hagen, Jürgen & Schuknecht, Ludger & Wolswijk, Guido, 2011. "Government bond risk premiums in the EU revisited: The impact of the financial crisis," European Journal of Political Economy, Elsevier, vol. 27(1), pages 36-43, March.
    3. Marta Gómez†Puig, 2009. "Systemic and Idiosyncratic Risk in EU†15 Sovereign Yield Spreads after Seven Years of Monetary Union," European Financial Management, European Financial Management Association, vol. 15(5), pages 971-1000, November.
    4. Acharya, Viral V. & Pedersen, Lasse Heje, 2005. "Asset pricing with liquidity risk," Journal of Financial Economics, Elsevier, vol. 77(2), pages 375-410, August.
    5. Bernoth, Kerstin & von Hagen, Jürgen & Schuknecht, Ludger, 2004. "Sovereign risk premia in the European government bond market," ZEI Working Papers B 26-2003, University of Bonn, ZEI - Center for European Integration Studies.
    6. Lorenzo Cappiello & Robert F. Engle & Kevin Sheppard, 2006. "Asymmetric Dynamics in the Correlations of Global Equity and Bond Returns," Journal of Financial Econometrics, Oxford University Press, vol. 4(4), pages 537-572.
    7. Favero, Carlo & Pagano, Marco & von Thadden, Ernst-Ludwig, 2010. "How Does Liquidity Affect Government Bond Yields?," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 45(1), pages 107-134, February.
    8. Abad, Pilar & Chuliá, Helena & Gómez-Puig, Marta, 2010. "EMU and European government bond market integration," Journal of Banking & Finance, Elsevier, vol. 34(12), pages 2851-2860, December.
    9. Harvey, Andrew & Ruiz, Esther & Sentana, Enrique, 1992. "Unobserved component time series models with Arch disturbances," Journal of Econometrics, Elsevier, vol. 52(1-2), pages 129-157.
    10. Favero, Carlo A & Giavazzi, Francesco & Spaventa, Luigi, 1997. "High Yields: The Spread on German Interest Rates," Economic Journal, Royal Economic Society, vol. 107(443), pages 956-985, July.
    11. Barr, David G. & Priestley, Richard, 2004. "Expected returns, risk and the integration of international bond markets," Journal of International Money and Finance, Elsevier, vol. 23(1), pages 71-97, February.
    12. Lorenzo Codogno & Carlo Favero & Alessandro Missale, 2003. "Yield spreads on EMU government bonds [‘Fiscal policy events and interest rate swap spreads: some evidence from the EU’]," Economic Policy, CEPR, CESifo, Sciences Po;CES;MSH, vol. 18(37), pages 503-532.
    13. Alois Geyer & Stephan Kossmeier & Stefan Pichler, 2004. "Measuring Systematic Risk in EMU Government Yield Spreads," Review of Finance, European Finance Association, vol. 8(2), pages 171-197.
    14. Guntram B. Wolff & Alexander Schulz, 2008. "Sovereign bond market integration: the euro, trading platforms and globalisation," European Economy - Economic Papers 2008 - 2015 332, Directorate General Economic and Financial Affairs (DG ECFIN), European Commission.
    15. Mardi Dungey & Vance L Martin & Adrian R Pagan, 2000. "A multivariate latent factor decomposition of international bond yield spreads," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 15(6), pages 697-715.
    16. S. J. Koopman & J. Durbin, 2000. "Fast Filtering and Smoothing for Multivariate State Space Models," Journal of Time Series Analysis, Wiley Blackwell, vol. 21(3), pages 281-296, May.
    17. Durbin, James & Koopman, Siem Jan, 2012. "Time Series Analysis by State Space Methods," OUP Catalogue, Oxford University Press, edition 2, number 9780199641178, Decembrie.
    18. Bekaert, Geert & Harvey, Campbell R, 1995. "Time-Varying World Market Integration," Journal of Finance, American Finance Association, vol. 50(2), pages 403-444, June.
    19. Alois Geyer & Stephan Kossmeier & Stefan Pichler, 2004. "Measuring Systematic Risk in EMU Government Yield Spreads," Review of Finance, Springer, vol. 8(2), pages 171-197.
    20. Harvey, Campbell R, 1991. "The World Price of Covariance Risk," Journal of Finance, American Finance Association, vol. 46(1), pages 111-157, March.
    21. von Hagen, Jurgen & Schuknecht, Ludger & Bernoth, Kerstin, 2004. "Sovereign Risk Premia in the European Bond Market," CEPR Discussion Papers 4465, C.E.P.R. Discussion Papers.
    22. Rob Luginbuhl & Siem Jan Koopman, 2004. "Convergence in European GDP series: a multivariate common converging trend-cycle decomposition," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 19(5), pages 611-636.
    23. Chang-Jin Kim & Charles R. Nelson, 1999. "State-Space Models with Regime Switching: Classical and Gibbs-Sampling Approaches with Applications," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262112388, December.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Lorenzo Pozzi & Guido Wolswijk, 2008. "Have Euro Area Government Bond Risk Premia Converged To Their Common State?," Tinbergen Institute Discussion Papers 08-042/2, Tinbergen Institute, revised 07 Sep 2009.
    2. T. Berger & L. Pozzi, 2011. "A new model-based approach to measuring time-varying financial market integration," Working Papers of Faculty of Economics and Business Administration, Ghent University, Belgium 11/714, Ghent University, Faculty of Economics and Business Administration.
    3. Samir Kadiric, 2020. "The determinants of sovereign risk premiums in the UK and the European government bond market: The impact of Brexit," EIIW Discussion paper disbei271, Universitätsbibliothek Wuppertal, University Library.
    4. Berger, Tino & Pozzi, Lorenzo, 2013. "Measuring time-varying financial market integration: An unobserved components approach," Journal of Banking & Finance, Elsevier, vol. 37(2), pages 463-473.
    5. Samir Kadiric, 2022. "The determinants of sovereign risk premiums in the UK and the European government bond market: the impact of Brexit," International Economics and Economic Policy, Springer, vol. 19(2), pages 267-298, May.
    6. Georgoutsos, Dimitris A. & Migiakis, Petros M., 2013. "Heterogeneity of the determinants of euro-area sovereign bond spreads; what does it tell us about financial stability?," Journal of Banking & Finance, Elsevier, vol. 37(11), pages 4650-4664.
    7. Georges Hübner & Robert Joliet, 2013. "Government Debt Denomination Policies Before and After the EMU Advent," Open Economies Review, Springer, vol. 24(2), pages 283-309, April.
    8. Schulz, Alexander & Wolff, Guntram B., 2009. "Sovereign bond market integration: the euro, trading platforms and financial crises," MPRA Paper 16900, University Library of Munich, Germany.
    9. Arghyrou, Michael G. & Kontonikas, Alexandros, 2012. "The EMU sovereign-debt crisis: Fundamentals, expectations and contagion," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 22(4), pages 658-677.
    10. Gerlach, Stefan & Wolff, Guntram B. & Schulz, Alexander, 2010. "Banking and Sovereign Risk in the Euro Area," CEPR Discussion Papers 7833, C.E.P.R. Discussion Papers.
    11. Oliveira, Luís & Curto, José Dias & Nunes, João Pedro, 2012. "The determinants of sovereign credit spread changes in the Euro-zone," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 22(2), pages 278-304.
    12. Ejsing, Jacob & Lemke, Wolfgang, 2011. "The Janus-headed salvation: Sovereign and bank credit risk premia during 2008-2009," Economics Letters, Elsevier, vol. 110(1), pages 28-31, January.
    13. Andrea Cipollini & Jerry Coakley & Hyunchul Lee, 2015. "The European sovereign debt market: from integration to segmentation," The European Journal of Finance, Taylor & Francis Journals, vol. 21(2), pages 111-128, January.
    14. Simón Sosvilla-Rivero & Amalia Morales-Zumaquero, 2012. "Volatility in EMU sovereign bond yields: permanent and transitory components," Applied Financial Economics, Taylor & Francis Journals, vol. 22(17), pages 1453-1464, September.
    15. Dionisis Philippas & Costas Siriopoulos, 2014. "Money factors and EMU government bond markets' convergence," Studies in Economics and Finance, Emerald Group Publishing Limited, vol. 31(2), pages 156-167, May.
    16. Luciana Barbosa & Sónia Costa, 2010. "Determinants of the sovereign bond yield spreads in the Euro Area in the context of the economic and financial crisis," Working Papers w201022, Banco de Portugal, Economics and Research Department.
    17. Borgy, V. & Laubach, T. & Mésonnier, J-S. & Renne, J-P., 2011. "Fiscal Sustainability, Default Risk and Euro Area Sovereign Bond Spreads Markets," Working papers 350, Banque de France.
    18. Gómez-Puig, Marta & Sosvilla-Rivero, Simón & Ramos-Herrera, María del Carmen, 2014. "An update on EMU sovereign yield spread drivers in times of crisis: A panel data analysis," The North American Journal of Economics and Finance, Elsevier, vol. 30(C), pages 133-153.
    19. Ms. Edda Zoli & Ms. Silvia Sgherri, 2009. "Euro Area Sovereign Risk During the Crisis," IMF Working Papers 2009/222, International Monetary Fund.
    20. Marta Gómez†Puig, 2009. "Systemic and Idiosyncratic Risk in EU†15 Sovereign Yield Spreads after Seven Years of Monetary Union," European Financial Management, European Financial Management Association, vol. 15(5), pages 971-1000, November.

    More about this item

    Keywords

    Government bonds; Financial market integration; Euro area; Risk premiums; State space methods;
    All these keywords.

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:eecrev:v:56:y:2012:i:1:p:36-53. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Catherine Liu (email available below). General contact details of provider: http://www.elsevier.com/locate/eer .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.