Sovereign Bond Yield Spillovers in the Euro Zone During the Financial and Debt Crisis

In this paper we examine the linkages of government bond yield spreads (BYS) between Euro zone countries over the period March 3, 2007 - June 18, 2012, thus considering the intriguing features of BYS spillovers during the global financial and the Euro zone debt crisis. Splitting our sample to Euro zone periphery and core countries, and using the VAR-based spillover index approach of Diebold and Yilmaz (2012), we find that: (i) on average, BYS shocks tend to increase future BYS, and are related to news announcements and policy changes; (ii) BYS spillovers between Euro zone countries are highly intertwined, originating mostly from the periphery (Greece, Ireland, Italy, Portugal and Spain (GIIPS)) and to a lesser extent from the core (Austria, Belgium, France and Netherlands (ABFN)). The within-effect of BYS spillovers is of greater magnitude within the periphery than that within the core; iv) The between-effect (core vs periphery) of BYS spillovers suggests directional spillovers of greater magnitude from the periphery to the Euro zone core than vice-versa. Generalized impulse response analyses provide additional support to these findings. Our findings highlight the increased vulnerability of Euro zone from the destabilizing shocks originating from the beleaguered Euro zone countries in the periphery.