Bond Yields, Sovereign Risk and Maturity Structure

Abstract

The aim of this paper is to analyze the relation between maturity structure, sovereign bond yields and sovereign risk in the Economic and Monetary Union for the period of 1990-2013. The results confirm the existence of an inverse relationship between sovereign bond yields, sovereign risk and the maturity structure of sovereign debt, regardless of the proxy that is used to measure sovereign risk and the time variance of the variables employed. The results indicate that risk shortens the maturity structure of sovereign debt because it reduces the stock of long-term debt. The relationship between maturity structure and sovereign bond yields differs depending on the risk of the countries analyzed (non-monotonic relationship) and the differences between peripheral and core countries are greater for higher levels of the yields. If we control for the indebtedness level of these countries, the results show that the relationship between the sovereign bond yields and maturity strengthens as the debt level increases.Risks 2018, 6, 109 2 of 25 maturity structure and credit risk has been analyzed in depth in the field of corporate finance, for instance in the works of Myers (1977), Flannery (1986 and Diamond (1991) and, more recently, in those of Baker et al. (2003) and Brunnermeier and Oehmke (2013), among others. However, there are fewer studies in the field of public finance in which the relationship between maturity and sovereign risk is analyzed, as public finance studies have paid more attention to other research topics, such as debt levels and risk premiums. Moreover, maturity structure is a fundamental tool in managing sovereign debt (Goudswaard 1990). Therefore, this paper attempts to extend the existing literature on this line of research, which is particularly interesting in the context of the current financial crisis.The results showed that sovereign bond yields, sovereign risk and the maturity structure of sovereign debt are inversely related. This finding indicates that an increase in the risk level shortens the maturity structure for the sample. Furthermore, the analysis of the debt maturity structure suggests it is reduced when the sovereign risk increases as the proportion of long-term debt reduces. Another interesting result was the existence of a non-monotonic relationship between sovereign bond yields and the maturity structure debt. We found evidence that in high risk countries (i.e., peripheral countries), the maturity structure of the debt shortens because of the increase in sovereign bond yields. However, in countries with lower risk (i.e., core countries 1 ), this inverse relationship is not as clear. If sovereign bond yields increase, the yields of long-term bonds from countries with higher sovereign risk (i.e., peripheral countries) increase to a greater extent than those of short-term bonds, i.e., the increase in the sovereign bond yields increases the term premium. Therefore, these countries resort to issuing short-term debt to reduce their funding costs. However, the yields of long-term governmen...