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Modelling and forecasting government bond spreads in the euro area: A GVAR model

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  • Favero, Carlo A.

Abstract

This paper proposes an extension to Global Vector Autoregressive (GVAR) models to capture time-varying interdependence among financial variables. Government bond spreads in the euro area feature a time-varying pattern of co-movement that poses a serious challenge for econometric modelling and forecasting. This pattern of the data is not captured by the standard specification that model spreads as persistent processes reverting to a time-varying mean determined by two factors: a local factor, driven by fiscal fundamentals and growth, and a global world factor, driven by the market’s appetite for risk. This paper argues that a third factor, expectations of exchange rate devaluation, gained traction during the crises. This factor is well captured via a GVAR that models the interdependence among spreads by making each country’s spread function of global European spreads. Global spreads capture the exposure of each country’s spread to other spreads in the euro area in terms of the time-varying ‘distance’ between their fiscal fundamentals. This new specification dominates the standard one in modelling the time-varying pattern of co-movements among spreads and the response of euro area spreads to the Greek debt crisis.

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  • Favero, Carlo A., 2013. "Modelling and forecasting government bond spreads in the euro area: A GVAR model," Journal of Econometrics, Elsevier, vol. 177(2), pages 343-356.
  • Handle: RePEc:eee:econom:v:177:y:2013:i:2:p:343-356
    DOI: 10.1016/j.jeconom.2013.04.004
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    More about this item

    Keywords

    Global VAR; Bond spreads in the euro-area; Exchange rate premium;
    All these keywords.

    JEL classification:

    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics

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