Dimitris A. Georgoutsos
Department of Accounting & Finance, Athens University of Economics & Business,
Petros M. Migiakis
Bank of Greece, Economic Research Department
In this paper we examine the dynamics of European sovereign bond yield spreads focusing on issues related to financial integration and market conditions. The finding of near-unit-root effects highlights the need for careful econometric specification. Thus we formulate sovereign bond yield spreads, for eleven EMU countries against the Bund for the period 1992:1-2009:12, as AR(1) processes, while allowing for regime switching effects, along the lines of a Markovian probabilistic specification. Specifically, by taking into account regime switching effects we examine, rather than assume, that monetary unification affected sovereign bond yield spreads, allowing for states of higher and lower interactions to be revealed. Next, we examine the effects of several exogenous explanatory variables. Our results indicate that European sovereign bonds achieved only partial integration even before the recent financial crisis, while financial integration and financial stability are found to be interconnected. Specifically, we find evidence of different effects exercised by the same deterministic factors on sovereign bond yield spreads even before the recent crisis. Additionally, it appears that a negative relation exists between low-volatility conditions and the magnitude of effects exercised by idiosyncratic risk factors on bond yield spreads.
Keywords: financial integration; sovereign bond spreads; near unit root; regime shifts
JEL classification: F21, 36, G12, G32
Acknowledgements: The authors would like to thank Heather Gibson, an anonymous referee and participants of the 14th Annual Conference on Macroeconomic Analysis and International Finance, for helpful comments and suggestions. The opinions expressed in this paper do not necessarily reflect the views of the institutions they are affiliated with.
Petros M. Migiakis
Economic Research Department,
Bank of Greece, 21 El. Venizelou Ave.,
10250, Athens, Greece,
Tel.: 0030-210-320 3587