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The time-varying integration of euro area government bond markets

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  • 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.

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Bibliographic Info

Article provided by Elsevier in its journal European Economic Review.

Volume (Year): 56 (2012)
Issue (Month): 1 ()
Pages: 36-53

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Handle: RePEc:eee:eecrev:v:56:y:2012:i:1:p:36-53

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Web page: http://www.elsevier.com/locate/eer

Related research

Keywords: Government bonds; Financial market integration; Euro area; Risk premiums; State space methods;

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References

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Citations

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Cited by:
  1. Charlotte Christiansen, 2012. "Integration of European Bond Markets," CREATES Research Papers 2012-33, School of Economics and Management, University of Aarhus.
  2. Riedel, Jana, 2013. "Real interest rate convergence among G7 countries," Annual Conference 2013 (Duesseldorf): Competition Policy and Regulation in a Global Economic Order 79928, Verein für Socialpolitik / German Economic Association.
  3. Antonakakis, Nikolaos, 2012. "Dynamic Correlations of Sovereign Bond Yield Spreads in the Euro zone and the Role of Credit Rating Agencies' Downgrades," MPRA Paper 43013, University Library of Munich, Germany.
  4. Berger, Tino & Pozzi, Lorenzo, 2013. "Measuring time-varying financial market integration: An unobserved components approach," Journal of Banking & Finance, Elsevier, Elsevier, vol. 37(2), pages 463-473.

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