Analyzing yield curve term structure and connectedness in the Eurozone and G7: A TVP-VAR approach

Financial markets have seen an increasing interdependence in the recent decades, imposing a dilemma of limiting the risks of transmission and taking the benefits of integration. This study analyzes the connectedness of systemic risk in the Eurozone and G7 sovereign bond markets, considering the short, medium, and long term of the yield curve influence on the risk propagation. To construct the term structure of the yield curve, we employ the dynamic Nelson-Siegel model giving the slope, level, and curvature. We also use the TVP-VAR connectedness approach to highlight the transmission of vulnerabilities. Our findings reveal that countries outside the Eurozone exhibit a higher level of connectivity and influence compared to some Eurozone countries. Systemic risk shows strong interdependence across all countries, as measured by various metrics of the term structure. We further investigate the impact of different durations on financial connectivity, noting that short- and medium-term durations, particularly within the Eurozone, show higher connectedness. Those strong relations are more important during COVID-19 crisis on slope and level. This paper highlights the implications of economic interdependencies and policy coordination, demonstrating how risks can propagate between countries regardless of their geographic or economic affiliations.