What are the driving factors behind the rise of spreads and CDSs of Euro-area sovereign bonds? A FAVAR model for Greece and Ireland

Apergis, Nicholas and Mamatzakis, Emmanuel (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. Working Paper. Levy Economics Institute of Bard College.

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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.

Item Type: Reports and working papers (Working Paper)
Additional Information: ISSN: 1547-366X
Schools and Departments: School of Business, Management and Economics > Business and Management
Subjects: H Social Sciences > HG Finance
Depositing User: Emmanuel Mamatzakis
Date Deposited: 12 Mar 2014 14:21
Last Modified: 27 May 2016 08:10
URI: http://sro.sussex.ac.uk/id/eprint/47823

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