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Sovereign spreads in the Euro Area. Which prospects for a Eurobond?

  • Carlo Favero
  • Alessandro Missale

In this paper, we provide new evidence on the determinants of sovereign yield spreads and contagion effects in the euro area in order to evaluate the rationale for a common Eurobond jointly guaranteed by euro-area Member States. We find that default risk is the main driver of yield spreads, suggesting small gains from greater liquidity. Fiscal fundamentals matter in the pricing of default risk but only as they interact with other countries’ yield spreads; i.e. with the global risk that the market perceives. More important, the impact of this global risk variable is not constant over time, a clear sign of contagion driven by shifts in market sentiment. This evidence points to a discontinuity in the disciplinary role of financial markets. If markets can stay irrational longer than a country can stay solvent, then the role of yield spreads on national bonds as a fiscal discipline device is considerably weakened, and issuing Eurobonds can be economically justified.

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Paper provided by IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University in its series Working Papers with number 424.

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Date of creation: 2011
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Handle: RePEc:igi:igierp:424
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  1. Fontana, Alessandro & Scheicher, Martin, 2010. "An analysis of euro area sovereign CDS and their relation with government bonds," Working Paper Series 1271, European Central Bank.
  2. Engle, Robert F. & Kroner, Kenneth F., 1995. "Multivariate Simultaneous Generalized ARCH," Econometric Theory, Cambridge University Press, vol. 11(01), pages 122-150, February.
  3. Alberto Alesina & Francesco Giavazzi, 2010. "Europe and the Euro," NBER Books, National Bureau of Economic Research, Inc, number ales08-1, August.
  4. Stephane Dees & Filippo di Mauro & M. Hashem Pesaran & L. Vanessa Smith, 2004. "Exploring the International Linkages of the Euro Area: A Global VAR Analysis," IEPR Working Papers 04.6, Institute of Economic Policy Research (IEPR).
  5. Edda Zoli & Silvia Sgherri, 2009. "Euro Area Sovereign Risk During the Crisis," IMF Working Papers 09/222, International Monetary Fund.
  6. Missale, Alessandro, 1999. "Public Debt Management," OUP Catalogue, Oxford University Press, number 9780198290858, March.
  7. Sergio Mayordomo & Juan Ignacio Peña & Eduardo S. Schwartz, 2009. "Towards a Common European Monetary Union Risk Free Rate," NBER Working Papers 15353, National Bureau of Economic Research, Inc.
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