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Interest rate spreads between Italy and Germany: 1995-1997

Listed author(s):
  • Marcello D'Amato
  • Barbara Pistoresi

In this paper the determinants of the long term yield spread between Italian and German government bonds are studied using daily observations for a period 1 January 1995-28 October 1997. Total spread is split into two main factors: an exchange rate factor, that is approximated by a differential on swap contracts (same maturity) and a default risk factor, that is considered as a residual. Cointegration analysis is used to test if the interest rates parity condition holds in the period considered and also the dynamic adjustment of total spread and its components is studied using impulse response analysis. The main result is that an uncovered parity condition cannot be rejected in the sample only if the relationship is augmented by the German short term interest rate. Impulse response analysis shows that this latter variable permanently affects the default risk. The main conclusion is that the reduction of the total spread in the period studied was due both to credibility gains and to favourable dynamics in the German interest rate.

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Article provided by Taylor & Francis Journals in its journal Applied Financial Economics.

Volume (Year): 11 (2001)
Issue (Month): 6 ()
Pages: 603-612

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Handle: RePEc:taf:apfiec:v:11:y:2001:i:6:p:603-612
DOI: 10.1080/096031001753266894
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