EMU-Sovereign Bonds: Yield Spread Determinants. Great Recession vs Sovereign Debt Crisis
After the outburst of the Great Recession in May 2008, the euro area sovereign yield spreads started to diverge, raising several questions about their potential drivers. A consensus was drawn towards the existence of a common factor that represents international risk aversion. The present thesis explores this conclusion, by incorporating a global financial stress index (in short GFSI), launched by Bank of America Merrill Lynch (BAML) in 2010. To shed light on the dynamics of the market-specific determinants, I initially conduct a series of OLS regressions in two subperiods: the Great Recession (2008-2010) and the Sovereign Debt Crisis (2010-2013). Besides, I expand my analysis by employing a dynamic OLS (DOLS) model to treat my results from a common characteristic of yield spreads; autocorrelation. I deploy this cointegrating model in the whole timespan of my dataset on both a country level and on an aggregate level. To achieve the latter, I construct market capitalization-weighted yield indices for the EMU core and peripheral countries. My results support that GFSI has a robust relationship with the majority of the EMU-yield spread differentials under bothcrises. Moreover, I conclude that, for countries with weak fiscal fundamentals, yield spreads are primarily explained by the country’s credit/liquidity profile and are prone to contagion risk. In contrast, for countries with robust macro-fundamentals yield spread differentials are mainly determined by global risk aversion and flight-to-liquidity, while contagion risk has a diminished effect.