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Does the halo effect still hold? Implications for the euro-candidates from the analysis of the EA bond market - the crisis perspective

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  • Szczypińska, Agnieszka

    () (Ministry of Finance in Poland)

Abstract

The euro area bond yield spreads have largely converged since the beginning of the EMU. However, during the crisis most eurozone members reported dramatic rise in government bond yield differentials to German Bunds due to deteriorating public finance and liquidity conditions as well as increase in investors' risk aversion. This paper provides an empirical analysis of determinants of government bond yield spreads in the euro area in the times of crisis. It indicates the significance of countries' fiscal performance and liquidity risk in explaining the evolution of bond differentials. It also demonstrates the conviction that credit rating is a forward looking variable, which financial markets immediately respond to, was inappropriate. It is proved credit rating is only a derivative factor of fiscal variables, not the fundamental one. Sovereign debt crisis led to change in the perception of EMU sovereign debt market. Nowadays, euro adoption does not automatically imply the lower profitability of new EA members' bonds. There is no more such a thing as "euro area level on interest rate". It seems to be more conditional on countries' macroeconomic policy. However, on the basis of panel estimation, it turned out that in case of almost all euro-candidates the theoretical values of the EMU convergence criterion bond yields (as they were the euro area members) would be significantly lower than the empirical ones. This suggests fiscal benefits from euro adoption might be substantial thus most countries with derogation should reassess their scale.

Suggested Citation

  • Szczypińska, Agnieszka, 2012. "Does the halo effect still hold? Implications for the euro-candidates from the analysis of the EA bond market - the crisis perspective," MF Working Papers 15, Ministry of Finance in Poland, revised 29 Aug 2012.
  • Handle: RePEc:ris:mfplwp:0015
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    euro area; sovereign bond yield spreads; convergence criteria; panel data;

    JEL classification:

    • C23 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Models with Panel Data; Spatio-temporal Models
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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