Fiscal Sustainability, Default Risk and Euro Area Sovereign Bond Spreads Markets
AbstractThis paper develops an arbitrage-free affine term structure model of potentially defaultable sovereign bonds to model a cross-section of eight euro area government bond yield curves since January 1999. The existence of a common monetary policy under European Monetary Union determines the short end of the yield curves, whereas decentralized debt policies drive expected default probabilities and thereby spreads towards Germany, assumed to be free of default risk. The pricing factors are three observable area-wide macroeconomic variables and measures of national fiscal sustainability, which we proxy by expected changes in debt/GDP ratios of the respective countries. Our model explains spreads both before and during the crisis to an impressive extent. The deterioration in public finances was the major driver of the widening in spreads since 2008 through both heightened compensations for default risk and increases in risk premia. We also present perceived probabilities of sovereign default at any maturity and assess their elasticity to shifts in expected changes in debt/GDP ratios.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by Banque de France in its series Working papers with number 350.
Length: 61 pages
Date of creation: 2011
Date of revision:
Government debt; affine term structure models; default risk; yield spreads; fiscal projections.;
Find related papers by JEL classification:
- C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
- E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
- H6 - Public Economics - - National Budget, Deficit, and Debt
This paper has been announced in the following NEP Reports:
- NEP-ALL-2011-11-14 (All new papers)
- NEP-CBA-2011-11-14 (Central Banking)
- NEP-EEC-2011-11-14 (European Economics)
- NEP-FMK-2011-11-14 (Financial Markets)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Glenn D. Rudebusch & Tao Wu, 2003.
"A macro-finance model of the term structure, monetary policy, and the economy,"
Working Paper Series
2003-17, Federal Reserve Bank of San Francisco.
- Glenn Rudebusch & Tao Wu, 2004. "A macro-finance model of the term structure, monetary policy, and the economy," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
- GlennD. Rudebusch & Tao Wu, 2008. "A Macro-Finance Model of the Term Structure, Monetary Policy and the Economy," Economic Journal, Royal Economic Society, vol. 118(530), pages 906-926, 07.
- Tao Wu & Glenn Rudebusch, 2004. "A Macro-Finance Model of the Term Structure, Monetary Policy, and the Economy," 2004 Meeting Papers 104, Society for Economic Dynamics.
- 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.
- Schuknecht, Ludger & von Hagen, Jürgen & Wolswijk, Guido, 2009. "Government Bond Risk Premiums in the EU revisited: The Impact of the Financial Crisis," CEPR Discussion Papers 7499, C.E.P.R. Discussion Papers.
- Schuknecht, Ludger & von Hagen, Jürgen & Wolswijk, Guido, 2010. "Government bond risk premiums in the EU revisited: the impact of the financial crisis," Working Paper Series 1152, European Central Bank.
- Ang, Andrew & Piazzesi, Monika, 2003.
"A no-arbitrage vector autoregression of term structure dynamics with macroeconomic and latent variables,"
Journal of Monetary Economics,
Elsevier, vol. 50(4), pages 745-787, May.
- Andrew Ang & Monika Piazzesi, 2001. "A No-Arbitrage Vector Autoregression of Term Structure Dynamics with Macroeconomic and Latent Variables," NBER Working Papers 8363, National Bureau of Economic Research, Inc.
- Alain Monfort & Jean-Paul Renne, 2011.
"Credit and Liquidity Risks in Euro-area Sovereign Yield Curves,"
2011-26, Centre de Recherche en Economie et Statistique.
- Monfort, A. & Renne, J-P., 2011. "Credit and liquidity risks in euro area sovereign yield curves," Working papers 352, Banque de France.
- Alessandro Beber & Michael W. Brandt & Kenneth A. Kavajecz, 2009.
"Flight-to-Quality or Flight-to-Liquidity? Evidence from the Euro-Area Bond Market,"
Review of Financial Studies,
Society for Financial Studies, vol. 22(3), pages 925-957, March.
- Alessandro Beber & Michael W. Brandt & Kenneth A. Kavajecz, 2006. "Flight-to-Quality or Flight-to-Liquidity? Evidence From the Euro-Area Bond Market," NBER Working Papers 12376, National Bureau of Economic Research, Inc.
- Maurizio Luisi & Jeffery D. Amato, 2006. "Macro factors in the term structure of credit spreads," BIS Working Papers 203, Bank for International Settlements.
- Kim, Don H. & Orphanides, Athanasios, 2005.
"Term Structure Estimation with Survey Data on Interest Rate Forecasts,"
CEPR Discussion Papers
5341, C.E.P.R. Discussion Papers.
- Kim, Don H. & Orphanides, Athanasios, 2012. "Term Structure Estimation with Survey Data on Interest Rate Forecasts," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 47(01), pages 241-272, February.
- Don H. Kim & Athanasios Orphanides, 2005. "Term structure estimation with survey data on interest rate forecasts," Finance and Economics Discussion Series 2005-48, Board of Governors of the Federal Reserve System (U.S.).
- Athanasios Orphanides & Don H. Kim, 2005. "Term Structure Estimation with Survey Data on Interest Rate Forecasts," Computing in Economics and Finance 2005 474, Society for Computational Economics.
- Christian Aßmann & Jens Hogrefe, 2009.
"Determinants of government bond spreads in the Euro area – in good times as in bad,"
Kiel Working Papers
1548, Kiel Institute for the World Economy.
- Christian Aßmann & Jens Boysen-Hogrefe, 2012. "Determinants of government bond spreads in the euro area: in good times as in bad," Empirica, Springer, vol. 39(3), pages 341-356, August.
- Edda Zoli & Silvia Sgherri, 2009. "Euro Area Sovereign Risk During the Crisis," IMF Working Papers 09/222, International Monetary Fund.
- Lorenzo Codogno & Carlo Favero & Alessandro Missale, 2003. "Yield spreads on EMU government bonds," Economic Policy, CEPR & CES & MSH, vol. 18(37), pages 503-532, October.
- Calvo, Guillermo A, 1988. "Servicing the Public Debt: The Role of Expectations," American Economic Review, American Economic Association, vol. 78(4), pages 647-61, September.
- Nelson, Charles R & Siegel, Andrew F, 1987. "Parsimonious Modeling of Yield Curves," The Journal of Business, University of Chicago Press, vol. 60(4), pages 473-89, October.
- Michael D. Bauer & Glenn D. Rudebusch & Jing (Cynthia) Wu, 2011. "Unbiased estimate of dynamic term structure models," Working Paper Series 2011-12, Federal Reserve Bank of San Francisco.
- Simone Manganelli & Guido Wolswijk, 2009. "What drives spreads in the euro area government bond market?," Economic Policy, CEPR & CES & MSH, vol. 24, pages 191-240, 04.
- Duffie, Darrell & Singleton, Kenneth J, 1999. "Modeling Term Structures of Defaultable Bonds," Review of Financial Studies, Society for Financial Studies, vol. 12(4), pages 687-720.
- Lemke, Wolfgang, 2007.
"An affine macro-finance term structure model for the euro area,"
Discussion Paper Series 1: Economic Studies
2007,13, Deutsche Bundesbank, Research Centre.
- Lemke, Wolfgang, 2008. "An affine macro-finance term structure model for the euro area," The North American Journal of Economics and Finance, Elsevier, vol. 19(1), pages 41-69, March.
- Gregory R. Duffee, 2002. "Term Premia and Interest Rate Forecasts in Affine Models," Journal of Finance, American Finance Association, vol. 57(1), pages 405-443, 02.
- 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.
- Bernoth, Kerstin & von Hagen, Jürgen & Schuknecht, Ludger, 2003.
"Sovereign risk premia in the European government bond market,"
ZEI Working Papers
B 26-2003, ZEI - Center for European Integration Studies, University of Bonn.
- Bernoth, Kerstin & von Hagen, Jürgen & Schuknecht, Ludger, 2004. "Sovereign risk premia in the European government bond market," Working Paper Series 0369, European Central Bank.
- Eisenschmidt, Jens & Tapking, Jens, 2009. "Liquidity risk premia in unsecured interbank money markets," Working Paper Series 1025, European Central Bank.
- David Haugh & Patrice Ollivaud & David Turner, 2009. "What Drives Sovereign Risk Premiums?: An Analysis of Recent Evidence from the Euro Area," OECD Economics Department Working Papers 718, OECD Publishing.
- Hilberg, Björn & Hollmayr, Josef, 2011. "Asset prices, collateral and unconventional monetary policy in a DSGE model," Working Paper Series 1373, European Central Bank.
- Giancarlo Corsetti & Keith Kuester & Andre Meier & Gernot J. Muller, 2011. "Soverign risk and the effects of fiscal retrenchment in deep recessions," Working Papers 11-43, Federal Reserve Bank of Philadelphia.
- Fouquau, Julien & Delatte, Anne-Laure & Bruneau, Catherine, 2012.
"Is the European sovereign crisis self-fulfilling? Empirical evidence about the drivers of market sentiments,"
Economics Papers from University Paris Dauphine
123456789/13144, Paris Dauphine University.
- Catherine Bruneau & Anne-Laure Delatte & Julien Fouquau, 2012. "Is the European sovereign crisis self-fulfilling ? Empirical evidence about the drivers of market sentiments," Documents de Travail de l'OFCE 2012-22, Observatoire Francais des Conjonctures Economiques (OFCE).
- Alberto Locarno & Alessandro Notarpietro & Massimiliano Pisani, 2013. "Sovereign risk, monetary policy and fiscal multipliers: a structural model-based assessment," Temi di discussione (Economic working papers) 943, Bank of Italy, Economic Research and International Relations Area.
- Hilberg, Björn & Hollmayr, Josef, 2013. "Asset prices, collateral, and unconventional monetary policy in a DSGE model," Discussion Papers 36/2013, Deutsche Bundesbank, Research Centre.
- Timo Henckel & Gordon D. Menzies & Daniel J. Zizzo, 2013.
"The Great Recession and the Two Dimensions of European Central Bank Credibility,"
CAMA Working Papers
2013-55, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
- Timo Henckel & Gordon Menzies & Daniel J. Zizzo, 2013. "The Great Recession and the Two Dimensions of European Central Bank Credibility," Working Paper Series 13, Economics Discipline Group, UTS Business School, University of Technology, Sydney.
- Agnieszka Szczypińska, 2012. "Does the halo effect still hold? Implications for the euro-candidates from the analysis of the EA bond market - the crisis perspective," Working Papers 15, Ministry of Finance in Poland.
- Carlo A. Favero, 2012. "Modelling and Forecasting Yield Differentials in the euro area. A non-linear Global VAR model," Working Papers 431, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Marie-Christine Petit-Djemad).
If references are entirely missing, you can add them using this form.