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

Levy Economics Institute, Working Papers Series

26 Pages Posted: 11 May 2012

See all articles by Nicholas Apergis

Nicholas Apergis

University of Piraeus; University of Derby

Emmanuel C. Mamatzakis

University of Sussex - School of Business, Management and Economics

Date Written: May 10, 2012

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.

Keywords: Sovereign Debt Crisis, Spreads, CDS, FAVAR Model, Greece and Ireland

JEL Classification: C32, G00, G01

Suggested Citation

Apergis, Nicholas and Mamatzakis, Emmanuel C., What are the Driving Factors Behind the Rise of Spreads and CDSs of Euro-area Sovereign Bonds? A FAVAR Model for Greece and Ireland (May 10, 2012). Levy Economics Institute, Working Papers Series. Available at SSRN: https://ssrn.com/abstract=2055803 or http://dx.doi.org/10.2139/ssrn.2055803

Nicholas Apergis (Contact Author)

University of Piraeus ( email )

Karaoli and Dimitriou 80
80 KARAOLI & DIMITRIOU STREET
Piraeus, Attiki 18534
Greece

University of Derby ( email )

Kedleston Road
Derby, Derbyshire DE22 1GB
United Kingdom

Emmanuel C. Mamatzakis

University of Sussex - School of Business, Management and Economics ( email )

Falmer, Brighton BN1 9SL
United Kingdom

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