Tail risk in the European sovereign bond market during the financial crises: Detecting the influence of the European Central Bank

Since 2008, the European Central Bank (ECB) is conducting an expansionary monetary policy on an unprecedented scale. The consequence is a historical low interest rate environment in the eurozone and inflated prices for the majority of euro area government bonds. This paper presents a study of the tail behavior of triple-A rated euro area government bonds during the financial crisis 2007/08, the European sovereign debt crisis and the episode of expansionary monetary policy by the ECB. First, the analysis determines whether daily returns of euro area government bonds exhibit fat tails. Second, tests are conducted for variation in tail risk among euro area government bonds with different maturities. Third, it is estimated whether the tail behavior has significantly changed during the financial crisis, the European sovereign debt crisis and the resulting market interventions by the ECB. The study is based on daily data of the spot yield curve for triple-A rated euro area government bonds with a remaining maturity from three months to thirty years. Evidence is found for fat tails for the left-and right-hand side of the return distribution for all considered bond maturities in the sample. Moreover, the results indicate a convex term structure of tail risks and a structural change in the tail behavior of short-term bonds with a remaining maturity of less than one year during the past two crises. In contrast, the test outcomes for the majority of the considered long-term bonds do not indicate any significant change in the tail behavior, despite the introduction of unconventional asset purchase programs by the ECB which directly target these securities.