Spillover effects on government bond yields in euro zone. Does full financial integration exist in European government bond markets?

Abstract

This paper examines the time varying nature of European government bond market integration by employing multivariate GARCH models. We state that unlike other bond markets, in euro markets the default(credit) risk factor and other macroeconomic and fiscal indicators are not able to explain the sovereign bond yields after the beginning of monetary union. This fact might be counted as a signal for perfect financial integration. However, we also find that the global shocks affect Germany and the rest of euro bond markets in various levels, creating particular discrepancies in asset prices even we take into account the market specific factors. Different level responses of each euro market to the global shocks reveal that euro bond markets are not fully integrated with each other unlike the recent literature claimed. Besides, we explore that the global factors are effective for the volatility of yield differentials among euro government bonds.

Nonlinear spillovers between euro area sovereign bond markets

“…Clearly, the interdependence between the markets has reduced. The results are thus in line with those of Arezki et al (2011), Balli (2008), Cronefey and Cronon, and Sgherri and Zoli (2009. We can no longer detect nonlinear spillovers running from Germany and France to the ˝periphery˝ euro area countries.…”

“…They fi nd that sovereign rating downgrades have statistically and economically signifi cant spillover effects both across countries and different segments of fi nancial markets. Balli (2008) investigates the European government bond market integration. He fi nds that the level of integration has changed during the global fi nancial crisis: while until the start of euro area crisis the sovereign bond markets of euro area seem integrated, during the fi nancial crisis different responses of each euro market to the global shocks reveal that euro bond markets are not fully integrated.…”

Income smoothing and foreign asset holdings

“…Also, considering recent literature to believe that international debt securities' trading does not have such power. This is consistent with recent studies by Pagano (2004), Codogno et al(2003), andBalli (2008). These authors find that there is a high correlation between bond markets which restrains income smoothing.…”

Sovereign bond yield spillovers in the Euro zone during the financial and debt crisis

“…Pre-crisis period (1999)(2000)(2001)(2002)(2003)(2004)(2005)(2006) During the pre-crisis period, on the one hand, Pagano (2004) shows that credit risk alone explaines a considerable portion of 10-year average yield differentials in EURO-zone countries during the 2001-2004 period, as a result of convergence after the transition to EMU. On the other hand, Balli (2009), who examines spillover effects on bond yields in Euro zone during 1999-2005, finds that unlike other bond markets, the credit risk factor and other macro and fiscal indicators are not sufficient to explain sovereign bond yield in these Euro countries after the beginning of the monetary union. Christiansen (2007) brakes down volatility to local, regional and global components, and finds evidence of substantial differences between the nature of the volatility of bonds of EMU member countries and non EMU member countries.…”