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Does the halo effect still hold? Implications for the euro-candidates from the analysis of the EA bond market - the crisis perspective

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  • Agnieszka Szczypińska

    ()
    (Ministry of Finance, Poland)

Abstract

The euro area bond yield spreads have largely converged since the beginning of the EMU. However, during the crisis most eurozone members reported dramatic rise in government bond yield differentials to German Bunds due to deteriorating public finance and liquidity conditions as well as increase in investors’ risk aversion. This paper provides an empirical analysis of determinants of government bond yield spreads in the euro area in the times of crisis. It indicates the significance of countries’ fiscal performance and liquidity risk in explaining the evolution of bond differentials. It also demonstrates the conviction that credit rating is a forward looking variable, which financial markets immediately respond to, was inappropriate. It is proved credit rating is only a derivative factor of fiscal variables, not the fundamental one. Sovereign debt crisis led to change in the perception of EMU sovereign debt market. Nowadays, euro adoption does not automatically imply the lower profitability of new EA members’ bonds. There is no more such a thing as “euro area level on interest rate”. It seems to be more conditional on countries’ macroeconomic policy. However, on the basis of panel estimation, it turned out that in case of almost all euro-candidates the theoretical values of the EMU convergence criterion bond yields (as they were the euro area members) would be significantly lower than the empirical ones. This suggests fiscal benefits from euro adoption might be substantial thus most countries with derogation should reassess their scale.

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File URL: http://www.mf.gov.pl/_files_/euro/publikacje_naukowe/working_papers/mf_wp_15.pdf
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Bibliographic Info

Paper provided by Ministry of Finance in Poland in its series Working Papers with number 15.

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Length: 19 pages
Date of creation: 29 Aug 2012
Date of revision:
Handle: RePEc:fpo:wpaper:15

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Web page: http://www.mf.gov.pl
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Keywords: euro area; sovereign bond yield spreads; convergence criteria; panel data;

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  1. Edda Zoli & Silvia Sgherri, 2009. "Euro Area Sovereign Risk During the Crisis," IMF Working Papers 09/222, International Monetary Fund.
  2. Schuknecht, Ludger & von Hagen, Jürgen & Wolswijk, Guido, 2008. "Government risk premiums in the bond market: EMU and Canada," Working Paper Series 0879, European Central Bank.
  3. Anna Iara & Guntram B. Wolff, 2010. "Rules and risk in the euro area: does rules-based national fiscal governance contain sovereign bond spreads?," European Economy - Economic Papers 433, Directorate General Economic and Monetary Affairs (DG ECFIN), European Commission.
  4. 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.
  5. Arghyrou, Michael G. & Kontonikas, Alexandros, 2010. "The EMU sovereign-debt crisis: Fundamentals, expectations and contagion," SIRE Discussion Papers 2010-81, Scottish Institute for Research in Economics (SIRE).
  6. Luciana Barbosa & Sónia Costa, 2010. "Determinants of sovereign bond yield spreads in the euro area in," Working Papers w201022, Banco de Portugal, Economics and Research Department.
  7. Bussiere Matthieu & Chudik Alexander & Mehl Arnaud, 2013. "How have global shocks impacted the real effective exchange rates of individual euro area countries since the euro’s creation?," The B.E. Journal of Macroeconomics, De Gruyter, vol. 13(1), pages 48, April.
  8. Carlo Favero & Alessandro Missale, 2011. "Sovereign spreads in the Euro Area. Which prospects for a Eurobond?," Working Papers 424, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  9. Salvador Barrios & Per Iversen & Magdalena Lewandowska & Ralph Setzer, 2009. "Determinants of intra-euro area government bond spreads during the financial crisis," European Economy - Economic Papers 388, Directorate General Economic and Monetary Affairs (DG ECFIN), European Commission.
  10. Alexopoulou, Ioana & Bunda, Irina & Ferrando, Annalisa, 2009. "Determinants of government bond spreads in new EU countries," Working Paper Series 1093, European Central Bank.
  11. Bernoth, Kerstin & Erdogan, Burcu, 2010. "Sovereign bond yield spreads: a time-varying coefficient approach," Discussion Papers 289, European University Viadrina Frankfurt (Oder), Department of Business Administration and Economics.
  12. Dimitris A. Georgoutsos & Petros Migiakis, 2010. "European sovereign bond spreads: monetary unification, market conditions and financial integration," Working Papers 115, Bank of Greece.
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