Central bank purchases of sovereign bonds in the euro area, the random walk hypothesis, and different measures of risk

The large purchase of public sector bonds (PSPP) by the ECB constitutes an interesting special case of quantitative easing (QE). It involved the purchase of risky, peripheral euro area government bonds—not by the ECB itself but by the national central banks at their own risk. The PSPP can be assimilated into a buy-back financed with senior debt, which should reduce the value of the remaining debt. Theory thus suggests that the PSPP should not be expected to have a positive impact on peripheral risk spreads. Empirical studies try to measure the impact of the asset purchases of central banks (QE) using the market reaction at the announcement date. The announcement effects are taken to be permanent because long-term rates are assumed to follow a random walk. We show that this assumption is not warranted for the risk spreads on bonds or the credit default swaps of peripheral euro area countries.