The effect of Behavioural Factors on the Government bond yield spread in the European Union.

The recent European sovereign debt crisis puts pressure on the conventional models which explain the government yield spread using 3 components; international risk factors, liquidity risk factors and country risk factors. Only limited research is done on the effect of behavioural factors. The main objective of this paper is to determine the effects of behavioural factors on the level of the 10 year government bond yield spread within two groups of Eurozone countries, GIIPS and SEZ, versus Germany. The empirical results show that the behavioural effects, which are indicators of the investors and consumers sentiment, have a significant effect on both the short run and long run. I also found that the effects of the behavioural variables are significantly larger in the GIIPS countries compared to the SEZ countries in all the models. This implicates that a change in the investor sentiment leads to a much stronger yield movement in the GIIPS countries.