What Are the Driving Factors behind the Rise of Spreads and CDSs of Euro-area Sovereign Bonds? A FAVAR Model for Greece and Ireland
This paper examines the underlying dynamics of selected euro-area sovereign bonds by employing a factor-augmenting vector autoregressive (FAVAR) model for the first time in the literature. This methodology allows for identifying the underlying transmission mechanisms of several factors; in particular, market liquidity and credit risk. Departing from the classical structural vector autoregressive (VAR) models, it allows us to relax limitations regarding the choice of variables that could drive spreads and credit default swaps (CDSs) of euro-area sovereign debts. The results show that liquidity, credit risk, and flight to quality drive both spreads and CDSs of five years' maturity over swaps for Greece and Ireland in recent years. Greece, in particular, is facing an elastic demand for its sovereign bonds that further stretches liquidity. Moreover, in current illiquid market conditions spreads will continue to follow a steep upward trend, with certain adverse financial stability implications. In addition, we observe a negative feedback effect from counterparty credit risk.
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Patrick Houweling & Ton Vorst, 2001.
"An Empirical Comparison of Default Swap Pricing Models,"
- Houweling, P. & Vorst, A.C.F., 2002. "An Empirical Comparison of Default Swap Pricing Models," ERIM Report Series Research in Management ERS-2002-23-F&A, Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus University Rotterdam.
- Patrick Houweling & Ton Vorst, 2002. "An Empirical Comparison of Default Swap Pricing Models," Tinbergen Institute Discussion Papers 02-004/2, Tinbergen Institute.
- Houweling, P. & Vorst, A.C.F., 2002. "An Empirical Comparison of Default Swap Pricing Models," Econometric Institute Research Papers ERS-2002-23-F&A, Erasmus University Rotterdam, Erasmus School of Economics (ESE), Econometric Institute.
- Andrew T. Levin & Alexei Onatski & John C. Williams & Noah Williams, 2005.
"Monetary policy under uncertainty in micro-founded macroeconometric models,"
Working Paper Series
2005-15, Federal Reserve Bank of San Francisco.
- Andrew T. Levin & Alexei Onatski & John Williams & Noah M. Williams, 2006. "Monetary Policy Under Uncertainty in Micro-Founded Macroeconometric Models," NBER Chapters, in: NBER Macroeconomics Annual 2005, Volume 20, pages 229-312 National Bureau of Economic Research, Inc.
- Noah Williams & Andrew Levin & Alexei Onatski, 2005. "Monetary Policy under Uncertainty in Micro-Founded Macroeconometric Models," Computing in Economics and Finance 2005 478, Society for Computational Economics.
- Andrew T. Levin & Alexei Onatski & John C. Williams & Noah Williams, 2005. "Monetary Policy Under Uncertainty in Micro-Founded Macroeconometric Models," NBER Working Papers 11523, National Bureau of Economic Research, Inc.
- Jarrow, Robert A & Lando, David & Turnbull, Stuart M, 1997. "A Markov Model for the Term Structure of Credit Risk Spreads," Review of Financial Studies, Society for Financial Studies, vol. 10(2), pages 481-523.
- Peña Sánchez de Rivera, Juan Ignacio & Forte, Santiago, 2006. "Credit spreads: theory and evidence about the information content of stocks, bonds and cdss," DEE - Working Papers. Business Economics. WB wb063310, Universidad Carlos III de Madrid. Departamento de Economía de la Empresa.
- Jarrow, Robert A & Turnbull, Stuart M, 1995. " Pricing Derivatives on Financial Securities Subject to Credit Risk," Journal of Finance, American Finance Association, vol. 50(1), pages 53-85, March.
When requesting a correction, please mention this item's handle: RePEc:lev:wrkpap:wp_720. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Marie-Celeste Edwards)
If references are entirely missing, you can add them using this form.