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Sovereign spreads in the Euro Area. Which prospects for a Eurobond?

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  • Carlo Favero
  • Alessandro Missale

Abstract

In this paper, we provide new evidence on the determinants of sovereign yield spreads and contagion effects in the euro area in order to evaluate the rationale for a common Eurobond jointly guaranteed by euro-area Member States. We find that default risk is the main driver of yield spreads, suggesting small gains from greater liquidity. Fiscal fundamentals matter in the pricing of default risk but only as they interact with other countries’ yield spreads; i.e. with the global risk that the market perceives. More important, the impact of this global risk variable is not constant over time, a clear sign of contagion driven by shifts in market sentiment. This evidence points to a discontinuity in the disciplinary role of financial markets. If markets can stay irrational longer than a country can stay solvent, then the role of yield spreads on national bonds as a fiscal discipline device is considerably weakened, and issuing Eurobonds can be economically justified.

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Paper provided by IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University in its series Working Papers with number 424.

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Date of creation: 2011
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Handle: RePEc:igi:igierp:424

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  1. Stephane Dees & Filippo di Mauro & M. Hashem Pesaran & L. Vanessa Smith, 2005. "Exploring the International Linkages of the Euro Area: a Global VAR Analysis," CESifo Working Paper Series 1425, CESifo Group Munich.
  2. Alberto Alesina & Francesco Giavazzi, 2010. "Europe and the Euro," NBER Books, National Bureau of Economic Research, Inc, number ales08-1, May.
  3. Edda Zoli & Silvia Sgherri, 2009. "Euro Area Sovereign Risk During the Crisis," IMF Working Papers 09/222, International Monetary Fund.
  4. Engle, Robert F. & Kroner, Kenneth F., 1995. "Multivariate Simultaneous Generalized ARCH," Econometric Theory, Cambridge University Press, vol. 11(01), pages 122-150, February.
  5. Fontana, Alessandro & Scheicher, Martin, 2010. "An analysis of euro area sovereign CDS and their relation with government bonds," Working Paper Series 1271, European Central Bank.
  6. Missale, Alessandro, 1999. "Public Debt Management," OUP Catalogue, Oxford University Press, number 9780198290858.
  7. Sergio Mayordomo & Juan Ignacio Peña & Eduardo S. Schwartz, 2009. "Towards a Common European Monetary Union Risk Free Rate," NBER Working Papers 15353, National Bureau of Economic Research, Inc.
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Cited by:
  1. Peter Claeys & Borek Vašícek, 2012. "“Measuring Sovereign Bond Spillover in Europe and the Impact of Rating News”," IREA Working Papers 201219, University of Barcelona, Research Institute of Applied Economics, revised Nov 2012.
  2. John Muellbauer, 2013. "Conditional eurobonds and the eurozone sovereign debt crisis," Oxford Review of Economic Policy, Oxford University Press, vol. 29(3), pages 610-645, AUTUMN.
  3. Dimitris A. Georgoutsos & Petros Migiakis, 2012. "Heterogeneity of the determinants of euro-area sovereign bond spreads; what does it tell us about financial stability?," Working Papers 143, Bank of Greece.
  4. Ashoka Mody & Stijn Claessens & Shahin Vallée, 2012. "Paths to Eurobonds," IMF Working Papers 12/172, International Monetary Fund.
  5. Philip R. Lane, 2012. "The European Sovereign Debt Crisis," Journal of Economic Perspectives, American Economic Association, vol. 26(3), pages 49-68, Summer.
  6. Gunther Tichy, 2012. "Zum Versagen der Marktdisziplinierung in der Finanzkrise," Perspektiven der Wirtschaftspolitik, Verein für Socialpolitik, vol. 13, pages 58-80, 05.
  7. Roberto Tamborini, 2012. "Market opinions, fundamentals and the euro-sovereign debt crisis," Department of Economics Working Papers 1210, Department of Economics, University of Trento, Italia.
  8. 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.
  9. Philip Lane, 2013. "Financial Globalisation and the Crisis," Open Economies Review, Springer, vol. 24(3), pages 555-580, July.
  10. António Afonso & Michael G. Arghyrou & Alexandros Kontonikas, 2012. "The determinants of sovereign bond yield spreads in the EMU," Working Papers 2012_14, Business School - Economics, University of Glasgow.
  11. Afonso, António & Arghyrou, Michael G. & Bagdatoglou, George & Kontonikas, Alexandros, 2013. "On the time-varying relationship between EMU sovereign spreads and their determinants," SIRE Discussion Papers 2013-47, Scottish Institute for Research in Economics (SIRE).
  12. Niels Gilbert & Jeroen Hessel & Silvie Verkaart, 2013. "Towards a Stable Monetary Union: What Role for Eurobonds?," DNB Working Papers 379, Netherlands Central Bank, Research Department.
  13. Canofari Paolo & Di Bartolomeo Giovanni & Piersanti Giovanni, 2013. "Theory and practice of contagion in monetary unions. Domino effects in EU Mediterranean countries: The case of Greece, Italy and Spain," wp.comunite 0098, Department of Communication, University of Teramo.
  14. 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.
  15. Gómez-Puig, Marta & Sosvilla-Rivero, Simón, 2013. "Granger-causality in peripheral EMU public debt markets: A dynamic approach," Journal of Banking & Finance, Elsevier, vol. 37(11), pages 4627-4649.

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