Sovereign credit risk dynamics in the European Monetary Union (EMU)

Abstract

The article provides evidence of the key determinants of the sovereign credit spreads by including some unique variables which proxy credit risk, country-specific risk, and international risk for 10 European Monetary Union (EMU) member countries. The findings suggest that though both country-specific and global risk factors significantly influence the sovereign yield spreads, the primary balance and not the forecast deficit is a key factor of credit spreads. Prior to the sovereign debt crisis, investors appear to focus mainly on the global risk-aversion factors. However, during the sovereign credit crisis only fiscal factors appear to affect the credit spreads while international risk factors have had little or no impact on the sovereign credit spreads.