Bond Yield Compression in the Countries Converging to the Euro
Lucjan T. Orlowski
Sacred Heart University - John F. Welch College of Business
German Institute for Economic Research (DIW Berlin)
William Davidson Working Paper No. 799
We demonstrate that bond yield compression is under way in the countries converging to the euro and that German yields are significant drivers of local currency yields. Based on the evidence from Poland, Hungary and the Czech Republic, we conclude that these new Member States of the European Union are ready to adopt the euro without risking a disruptive shock to their financial stability. This message transpires from investigating the daily volatility dynamics of local bond yields as a function of German yields, conditional on changes in local term spreads, exchange rates and adjustments to central bank reference rates. Similar results of high sensitivity of local currency bond yields to changes in German yields are obtained from testing monthly series of macroeconomic fundamentals. These findings provide evidence of the potential usefulness of term spreads as indicators of monetary convergence.
Number of Pages in PDF File: 32
Keywords: term spread, term premium, yield compression, monetary convergence, new Member States, EMU, conditional volatility, asymmetric GARCH models
JEL Classification: E43, E44, F36
Date posted: May 8, 2006
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