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Benchmark yield undershooting in the E.M.U

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  • Antzoulatos, Angelos A.

Abstract

With the elimination of foreign exchange risk among the E.M.U.-member countries, the yield of, say, French benchmark government bonds (henceforth, the yield) should be equal to that of German bonds, plus some credit and liquidity premia. Since both premia are not likely to change substantially from one day to the other, the yield should move in tandem with the German one and the corresponding spread should remain relatively stable. Yet, the yield exhibits a small but economically and statistically significant undershooting in response to changes in the German one, as a result of which the spread tends to decline when the latter increases, and vice-versa. We propose that the undershooting is the product of lagged adjustment in the European bond portfolios that is driven by liquidity considerations and, in particular, by the possibility of excessive bond-price movements in response to changes in the German yield. The empirical results are consistent with this proposition and additionally suggest that the adjustment can last for as long as four days. --

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Bibliographic Info

Paper provided by Hamburg Institute of International Economics (HWWA) in its series HWWA Discussion Papers with number 191.

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Date of creation: 2002
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Handle: RePEc:zbw:hwwadp:26207

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Keywords: Benchmark Government Bonds; E.M.U.; Credit and Liquidity Premia; Bid/Ask Spread;

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References

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  1. Wolfgang Schulte & Roberto Violi, 2001. "Interactions between cash and derivatives bond markets: some evidence for the euro area," BIS Papers chapters, Bank for International Settlements, in: Bank for International Settlements (ed.), The changing shape of fixed income markets: a collection of studies by central bank economists, volume 5, pages 67-112 Bank for International Settlements.
  2. Michael J. Fleming, 2001. "Measuring treasury market liquidity," Staff Reports, Federal Reserve Bank of New York 133, Federal Reserve Bank of New York.
  3. Stefan Gerlach, 1996. "Monetary policy and the behaviour of interest rates: are long rates excessively volatile?," BIS Working Papers 34, Bank for International Settlements.
  4. Allen M. Poteshman, 2001. "Underreaction, Overreaction, and Increasing Misreaction to Information in the Options Market," Journal of Finance, American Finance Association, American Finance Association, vol. 56(3), pages 851-876, 06.
  5. John Y. Campbell & Robert J. Shiller, 1989. "Yield Spreads and Interest Rate Movements: A Bird's Eye View," NBER Working Papers 3153, National Bureau of Economic Research, Inc.
  6. Paul Bennett & Kenneth Garbade & John Kambhu, 1999. "Enhancing the Liquidity of U.S. Treasury Securities in an Era of Surpluses," New York University, Leonard N. Stern School Finance Department Working Paper Seires, New York University, Leonard N. Stern School of Business- 99-083, New York University, Leonard N. Stern School of Business-.
  7. Hardouvelis, Gikas A., 1994. "The term structure spread and future changes in long and short rates in the G7 countries: Is there a puzzle?," Journal of Monetary Economics, Elsevier, Elsevier, vol. 33(2), pages 255-283, April.
  8. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 84(6), pages 1161-76, December.
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Cited by:
  1. GRENADE, Kari & MOORE, Winston, 2008. "Co-Movements Between Foreign And Domestic Interest Rates In A Fixed Exchange Rate Regime: The Case Of The Eccu And The Us," Applied Econometrics and International Development, Euro-American Association of Economic Development, Euro-American Association of Economic Development, vol. 8(1), pages 119-130.

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