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Modelling and Forecasting Yield Differentials in the euro area. A non-linear Global VAR model

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  • Carlo A. Favero

Abstract

Unstability in the comovement among bond spreads in the euro area is an important feature for dynamic econometric modelling and forecasting. This paper proposes a non-linear GVAR approach to spreads in the euro area where the changing interdepence among these variables is modelled by making each country spread function of a global variable determined by fiscal fundamentals with a time-varying composition. The model naturally accommodates the possibility of multiple equilibria in the relation between default premia and local fiscal fundamentals. The estimation reveals a significant non-linear relation between spreads and fiscal fundamentals that generates time-varying impulse response of local spreads to shocks in other euro area countries spreads. The GVAR framework is then applied to the analysis of the dynamic effects of fiscal stabilization packages on the cost of government borrowing and to the evaluation of the importance of potential contagion effects determining a significant increase in cross-market linkages after a shock to a group of countries.

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Bibliographic Info

Paper provided by IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University in its series Working Papers with number 431.

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Date of creation: 2012
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Handle: RePEc:igi:igierp:431

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  1. Filippo di Mauro & L. Vanessa Smith & Stephane Dees & M. Hashem Pesaran, 2007. "Exploring the international linkages of the euro area: a global VAR analysis," Journal of Applied Econometrics, John Wiley & Sons, Ltd., John Wiley & Sons, Ltd., vol. 22(1), pages 1-38.
  2. Bernoth, Kerstin & von Hagen, Jürgen & Schuknecht, Ludger, 2003. "Sovereign risk premia in the European government bond market," ZEI Working Papers, ZEI - Center for European Integration Studies, University of Bonn B 26-2003, ZEI - Center for European Integration Studies, University of Bonn.
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  4. Lorenzo Codogno & Carlo Favero & Alessandro Missale, 2003. "Yield spreads on EMU government bonds," Economic Policy, CEPR;CES;MSH, CEPR;CES;MSH, vol. 18(37), pages 503-532, October.
  5. Christian Aßmann & Jens Boysen-Hogrefe, 2012. "Determinants of government bond spreads in the euro area: in good times as in bad," Empirica, Springer, Springer, vol. 39(3), pages 341-356, August.
  6. P. Hiebert & I. Vansteenkiste, 2010. "International trade, technological shocks and spillovers in the labour market: a GVAR analysis of the US manufacturing sector," Applied Economics, Taylor & Francis Journals, Taylor & Francis Journals, vol. 42(24), pages 3045-3066.
  7. Favero, Carlo A. & Missale, Alessandro, 2011. "Sovereign spreads in the Euro area: Which prospects for a Eurobond?," CEPR Discussion Papers, C.E.P.R. Discussion Papers 8637, C.E.P.R. Discussion Papers.
  8. Silvia Sgherri & Alessandro Galesi, 2009. "Regional Financial Spillovers Across Europe," IMF Working Papers, International Monetary Fund 09/23, International Monetary Fund.
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  10. Simone Manganelli & Guido Wolswijk, 2009. "What drives spreads in the euro area government bond market?," Economic Policy, CEPR;CES;MSH, CEPR;CES;MSH, vol. 24, pages 191-240, 04.
  11. Borgy, V. & Laubach, T. & Mésonnier, J-S. & Renne, J-P., 2011. "Fiscal Sustainability, Default Risk and Euro Area Sovereign Bond Spreads Markets," Working papers, Banque de France 350, Banque de France.
  12. Engle, Robert F. & Kroner, Kenneth F., 1995. "Multivariate Simultaneous Generalized ARCH," Econometric Theory, Cambridge University Press, Cambridge University Press, vol. 11(01), pages 122-150, February.
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  14. 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.
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