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The Determinants of Country Risk Premium Volatility: Evidence from a Panel VAR Model

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  • Petra Palic

    (The Institute of Economics, Zagreb, Croatia)

  • Petra Posedel Simovic

    (Zagreb School of Economics and Management, Zagreb, Croatia)

  • Maruska Vizek

    (The Institute of Economics, Zagreb, Croatia)

Abstract

We use data for 24 European countries, spanning from 1994 to 2015, in order to examine how changes in macroeconomic conditions influence country risk premium volatility proxied by sovereign spreads variance. In the first part of the empirical analysis, we estimate the univariate generalized autoregressive conditional heteroskedasticity (GARCH) model in order to obtain the conditional variance of sovereign bond spreads. We show that an increase in this variance coincides with economic and financial crisis occurring either in the country or globally. In the second part of the empirical analysis, we estimate the panel vector autoregression (panel VAR) model in order to model the interplay between macroeconomic fundamentals (inflation, output gap, public debt and interest rates) and the country’s risk premium volatility. We show that overheating of the economy, along with an unexpected increase in public debt, inflation and interest rates, increase the country’s risk premium volatility. We also show that a sudden increase in the country´s risk premium volatility depresses the economy, exerts deflationary pressures on consumer prices, and is followed by a strong and permanent increase in public debt.

Suggested Citation

  • Petra Palic & Petra Posedel Simovic & Maruska Vizek, 2017. "The Determinants of Country Risk Premium Volatility: Evidence from a Panel VAR Model," Croatian Economic Survey, The Institute of Economics, Zagreb, vol. 19(1), pages 37-66, June.
  • Handle: RePEc:iez:survey:ces-v19_1-2017_palic-posedelsimovic-vizek
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    Cited by:

    1. Taguchi, Hiroyuki, 2021. "Determinants of country risk premium revisit: Evidence for emerging market and developing economies," MPRA Paper 107078, University Library of Munich, Germany.

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    More about this item

    Keywords

    sovereign bond markets; panel VAR; European Union;
    All these keywords.

    JEL classification:

    • C33 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Models with Panel Data; Spatio-temporal Models
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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