Determinants of Spreads of Romanian Sovereign bonds. An application on the EMBIG spreads

There was a rapid compression in the spreads of Romanian sovereign bonds in last years, to a record low level reached in the summer of 2007. We show that the developments in the domestic fundamentals and in the risk appetite of foreign investors on the international markets explain the developments in the spreads. Using data for EMBIG spreads for Romania and other ten Emerging Economies, we find a long-run relationship between the spreads on the one hand and a Credit Rating Outlook Index (CROI) and the volatility index VIX on the other hand. The CROI is a proxy for the developments in the domestic fundamentals, while the VIX is a proxy for the risk appetite of the international investors. To estimate the long-run relationship, we use both a pool equation with fixed effects and the pooled mean group (PMG) estimator of Pesaran, Shin, and Smith (1997). There is a large similitude between the deviations of spreads from the level implied by the long-run relationship in the case of Bulgaria and Romania, which we explain by the EU accession process of these two countries. We find also a comovement in the volatility of daily returns of CEE sovereign bonds, with spillover effects especially between Bulgaria and Romania. The domestic fundamentals were the main drivers of the cumulated change in the equilibrium level of spreads for Romanian sovereign bonds between May 2002 and April 2008.