What can EMU countries' sovereign bond spreads tell us about market perceptions of default probabilities during the recent financial crisis?
AbstractThis paper presents a new approach for analysing the recent development of EMU sovereign bond spreads. Based on a GARCH-in-mean model originally used in the exchange rate target zone literature, spreads are decomposed into a risk premium, an expected loss component and a liquidity premium. Time-varying default probabilities are derived. The results suggest that the rise in sovereign spreads during the recent financial crisis mainly reflects an increased expected loss component. In addition, the rescue of Bear Stearns in March 2008 seems to mark a change in market perceptions of sovereign bond risk. The government bonds of some countries lost their former role as a safe haven. While price competitiveness always helps to explain sovereign spreads, it increasingly moved into investors' focus as financial sector soundness weakened. --
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Bibliographic InfoPaper provided by Deutsche Bundesbank, Research Centre in its series Discussion Paper Series 1: Economic Studies with number 2010,11.
Date of creation: 2010
Date of revision:
Sovereign bond spread; GARCH-in-mean; default probability;
Find related papers by JEL classification:
- E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
- G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
- C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
- H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt
- F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration
This paper has been announced in the following NEP Reports:
- NEP-ALL-2010-07-03 (All new papers)
- NEP-EEC-2010-07-03 (European Economics)
- NEP-FMK-2010-07-03 (Financial Markets)
- NEP-IFN-2010-07-03 (International Finance)
- NEP-MAC-2010-07-03 (Macroeconomics)
- NEP-RMG-2010-07-03 (Risk Management)
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