IDEAS home Printed from https://ideas.repec.org/p/lev/wrkpap/wp_720.html
   My bibliography  Save this paper

What Are the Driving Factors behind the Rise of Spreads and CDSs of Euro-area Sovereign Bonds? A FAVAR Model for Greece and Ireland

Author

Listed:
  • Nicholas Apergis
  • Emmanuel Mamatzakis

Abstract

This paper examines the underlying dynamics of selected euro-area sovereign bonds by employing a factor-augmenting vector autoregressive (FAVAR) model for the first time in the literature. This methodology allows for identifying the underlying transmission mechanisms of several factors; in particular, market liquidity and credit risk. Departing from the classical structural vector autoregressive (VAR) models, it allows us to relax limitations regarding the choice of variables that could drive spreads and credit default swaps (CDSs) of euro-area sovereign debts. The results show that liquidity, credit risk, and flight to quality drive both spreads and CDSs of five years' maturity over swaps for Greece and Ireland in recent years. Greece, in particular, is facing an elastic demand for its sovereign bonds that further stretches liquidity. Moreover, in current illiquid market conditions spreads will continue to follow a steep upward trend, with certain adverse financial stability implications. In addition, we observe a negative feedback effect from counterparty credit risk.

Suggested Citation

  • Nicholas Apergis & Emmanuel Mamatzakis, 2012. "What Are the Driving Factors behind the Rise of Spreads and CDSs of Euro-area Sovereign Bonds? A FAVAR Model for Greece and Ireland," Economics Working Paper Archive wp_720, Levy Economics Institute.
    • Handle: RePEc:lev:wrkpap:wp_720
    as

    Download full text from publisher

    File URL: http://www.levyinstitute.org/pubs/wp_720.pdf
    Download Restriction: no
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. Patrick Houweling & Ton Vorst, 2001. "An Empirical Comparison of Default Swap Pricing Models," Finance 0112003, University Library of Munich, Germany.
    2. Andrew T. Levin & Alexei Onatski & John Williams & Noah M. Williams, 2006. "Monetary Policy under Uncertainty in Micro-Founded Macroeconometric Models," NBER Chapters, in: NBER Macroeconomics Annual 2005, Volume 20, pages 229-312, National Bureau of Economic Research, Inc.
    3. Norden, Lars & Weber, Martin, 2004. "The comovement of credit default swap, bond and stock markets: An empirical analysis," CFS Working Paper Series 2004/20, Center for Financial Studies (CFS).
    4. Robert A. Jarrow & David Lando & Stuart M. Turnbull, 2008. "A Markov Model for the Term Structure of Credit Risk Spreads," World Scientific Book Chapters, in: Financial Derivatives Pricing Selected Works of Robert Jarrow, chapter 18, pages 411-453, World Scientific Publishing Co. Pte. Ltd..
    5. Robert A. Jarrow & Stuart M. Turnbull, 2008. "Pricing Derivatives on Financial Securities Subject to Credit Risk," World Scientific Book Chapters, in: Financial Derivatives Pricing Selected Works of Robert Jarrow, chapter 17, pages 377-409, World Scientific Publishing Co. Pte. Ltd..
    6. Ben S. Bernanke & Jean Boivin & Piotr Eliasz, 2005. "Measuring the Effects of Monetary Policy: A Factor-Augmented Vector Autoregressive (FAVAR) Approach," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 120(1), pages 387-422.
    7. Longstaff, Francis A & Schwartz, Eduardo S, 1995. "A Simple Approach to Valuing Risky Fixed and Floating Rate Debt," Journal of Finance, American Finance Association, vol. 50(3), pages 789-819, July.
    8. Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 29(2), pages 449-470, May.
    9. Haibin Zhu, 2006. "An Empirical Comparison of Credit Spreads between the Bond Market and the Credit Default Swap Market," Journal of Financial Services Research, Springer;Western Finance Association, vol. 29(3), pages 211-235, June.
    10. Forte, Santiago, 2006. "Credit spreads: theory and evidence about the information content of stocks, bonds and cdss," DEE - Working Papers. Business Economics. WB wb063310, Universidad Carlos III de Madrid. Departamento de Economía de la Empresa.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Pegkas Panagiotis, 2019. "Government Debt and Economic Growth. A Threshold Analysis for Greece," Peace Economics, Peace Science, and Public Policy, De Gruyter, vol. 25(1), pages 1-6, February.
    2. Panagiotis Pegkas, 2018. "The Effect of Government Debt and Other Determinants on Economic Growth: The Greek Experience," Economies, MDPI, vol. 6(1), pages 1-19, February.
    3. Benbouzid, Nadia & Mallick, Sushanta & Pilbeam, Keith, 2018. "The housing market and the credit default swap premium in the UK banking sector: A VAR approach," Research in International Business and Finance, Elsevier, vol. 44(C), pages 1-15.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Brian BARNARD, 2017. "Rating Migration and Bond Valuation: Decomposing Rating Migration Matrices from Market Data via Default Probability Term Structures," Expert Journal of Finance, Sprint Investify, vol. 5(1), pages 49-72.
    2. Roberto Blanco & Simon Brennan & Ian W. Marsh, 2004. "An empirical analysis of the dynamic relationship between investment grade bonds and credit default swaps," Working Papers 0401, Banco de España.
    3. Brian BARNARD, 2017. "Rating Migration and Bond Valuation: Decomposing Rating Migration Matrices from Market Data via Default Probability Term Structures," Expert Journal of Finance, Sprint Investify, vol. 5, pages 49-72.
    4. Abel Elizalde, 2006. "Credit Risk Models I: Default Correlation in Intensity Models," Working Papers wp2006_0605, CEMFI.
    5. Antonio Trujillo-Ponce & Reyes Samaniego-Medina & Clara Cardone-Riportella, 2014. "Examining what best explains corporate credit risk: accounting-based versus market-based models," Journal of Business Economics and Management, Taylor & Francis Journals, vol. 15(2), pages 253-276, April.
    6. repec:wyi:journl:002109 is not listed on IDEAS
    7. Finbarr Murphy & Bernard Murphy, 2012. "A vector-autoregression analysis of credit and liquidity factor dynamics in US LIBOR and Euribor swap markets," Journal of Economics and Finance, Springer;Academy of Economics and Finance, vol. 36(2), pages 351-370, April.
    8. Didier Cossin & Tomas Hricko & Daniel Aunon-Nerin & Zhijiang Huang, 2002. "Exploring for the Determinants of Credit Risk in Credit Default Swap Transaction Data: Is Fixed-Income Markets’ Information Suffcient to Evaluate Credit Risk?," FAME Research Paper Series rp65, International Center for Financial Asset Management and Engineering.
    9. Brian BARNARD, 2018. "Rating Migration and Bond Valuation: Ahistorical Interest Rate and Default Probability Term Structures," Expert Journal of Finance, Sprint Investify, vol. 6(1), pages 16-30.
    10. Hong-Ming Yin & Jin Liang & Yuan Wu, 2018. "On a New Corporate Bond Pricing Model with Potential Credit Rating Change and Stochastic Interest Rate," JRFM, MDPI, vol. 11(4), pages 1-12, December.
    11. Augusto Castillo, 2004. "Firm and Corporate Bond Valuation: A Simulation Dynamic Programming Approach," Latin American Journal of Economics-formerly Cuadernos de Economía, Instituto de Economía. Pontificia Universidad Católica de Chile., vol. 41(124), pages 345-360.
    12. Regis Houssou & Olivier Besson, 2010. "Indifference of Defaultable Bonds with Stochastic Intensity models," Papers 1003.4118, arXiv.org.
    13. Giesecke, Kay & Longstaff, Francis A. & Schaefer, Stephen & Strebulaev, Ilya, 2011. "Corporate bond default risk: A 150-year perspective," Journal of Financial Economics, Elsevier, vol. 102(2), pages 233-250.
    14. Samuel Chege Maina, 2011. "Credit Risk Modelling in Markovian HJM Term Structure Class of Models with Stochastic Volatility," PhD Thesis, Finance Discipline Group, UTS Business School, University of Technology, Sydney, number 1-2011, January-A.
    15. Maclachlan, Iain C, 2007. "An empirical study of corporate bond pricing with unobserved capital structure dynamics," MPRA Paper 28416, University Library of Munich, Germany.
    16. Lando, David & Mortensen, Allan, 2004. "On the Pricing of Step-Up Bonds in the European Telecom Sector," Working Papers 2004-9, Copenhagen Business School, Department of Finance.
    17. Bank for International Settlements, 2011. "Portfolio and risk management for central banks and sovereign wealth funds," BIS Papers, Bank for International Settlements, number 58.
    18. Sorin Gabriel Anton, 2011. "The Local Determinants Of Emerging Market Sovereign Cds Spreads In The Context Of The Debt Crisis. An Explanatory Study "," Analele Stiintifice ale Universitatii "Alexandru Ioan Cuza" din Iasi - Stiinte Economice (1954-2015), Alexandru Ioan Cuza University, Faculty of Economics and Business Administration, vol. 58, pages 41-52, november.
    19. Jose Giancarlo Gasha & Mr. Andre O Santos & Mr. Jorge A Chan-Lau & Mr. Carlos I. Medeiros & Mr. Marcos R Souto & Christian Capuano, 2009. "Recent Advances in Credit Risk Modeling," IMF Working Papers 2009/162, International Monetary Fund.
    20. Zhehao Huang & Zhenghui Li & Zhenzhen Wang, 2020. "Utility Indifference Valuation for Defaultable Corporate Bond with Credit Rating Migration," Mathematics, MDPI, vol. 8(11), pages 1-26, November.
    21. Gatzert, Nadine & Martin, Michael, 2012. "Quantifying credit and market risk under Solvency II: Standard approach versus internal model," Insurance: Mathematics and Economics, Elsevier, vol. 51(3), pages 649-666.

    More about this item

    Keywords

    Sovereign Debt Crisis; Spreads; CDS; FAVAR Model; Greece and Ireland;
    All these keywords.

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • G00 - Financial Economics - - General - - - General
    • G01 - Financial Economics - - General - - - Financial Crises

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:lev:wrkpap:wp_720. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Elizabeth Dunn (email available below). General contact details of provider: http://www.levyinstitute.org .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.