Financial Indicators Signalling Correlation Changes in Sovereign Bond Markets

39 Pages Posted: 15 Dec 2014

See all articles by Roberto A. De Santis

Roberto A. De Santis

European Central Bank (ECB) - Directorate General Economics

Michael Stein

University of Duisburg-Essen

Date Written: November 21, 2014

Abstract

We use a Smooth Transition Conditional Correlation GARCH (STCC-GARCH) model applied to the euro area monetary policy rates and sovereign yields of Italy, Spain and Germany at 5-year maturity to estimate the threshold level of the signals above which the sovereign bond market moves to a crisis regime. We show that the threshold to a crisis regime for Italy and Spain is reached when (i) their 5-year sovereign yield spreads amount to 80-90 basis points; (ii) their 5-year CDS spreads amount to 120-130 basis points or (iii) the 5-year spread between the Kreditanstalt f├╝r Wiederaufbau (KfW) bond and the German Bund amounts to 25 basis points. Using impulse responses, we find that the STCC-GARCH with the KfW-Bund spread has leading properties, a feature corroborated by the fact that this indicator suggested a shift to a crisis regime already in August 2007 and has been signalling an improvement of the situation already in the autumn of 2012. An out-of-sample forecast of the STCC-GARCH model is also provided, which is both a novelty and a further robustness check for the stability of the model.

Keywords: correlation breakdowns, monetary policy, regime changes, government bonds, multivariate GARCH

JEL Classification: G12, G15, F36

Suggested Citation

De Santis, Roberto A. and Stein, Michael, Financial Indicators Signalling Correlation Changes in Sovereign Bond Markets (November 21, 2014). ECB Working Paper No. 1746. Available at SSRN: https://ssrn.com/abstract=2529077

Roberto A. De Santis

European Central Bank (ECB) - Directorate General Economics ( email )

Kaiserstrasse 29
D-60311 Frankfurt am Main
Germany

Michael Stein (Contact Author)

University of Duisburg-Essen ( email )

Universit├Ątsst. 12
Duisburg, 45117
Germany

HOME PAGE: http://www.fmoek.wiwi.uni-due.de/

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