Bond Risk Premia, Macroeconomic Factors and Financial Crisis in the Euro Area

Louvain School of Management Working Paper Series No. 2015/14

89 Pages Posted: 9 Oct 2015

See all articles by Juan A. Garcia

Juan A. Garcia

European Central Bank (ECB)

Sebastian Werner

Catholic University of Louvain (UCL)

Multiple version iconThere are 2 versions of this paper

Date Written: June 15, 2015

Abstract

This paper investigates the power of macroeconomic factors to explain euro area bond risk premia using (i) a big dataset (ii) the Elastic Net variable selection. We find that macroeconomic factors, in particular economic activity and sentiment indicators, explain 40% of the variability of risk premia before the crisis, and up to 55% during the financial crisis, and both for core countries (from 40% to 60%) and periphery countries (from 35% to 44%). Moreover, macroeconomic factor models clearly outperform financial indicators like the CP-factor and credit default swap (CDS) premia, even in periods of significant market turbulence.

Keywords: Bond risk premium, Macro Factors, Financial Crisis, Model Selection, Variable Selection

JEL Classification: E43, E44, G01, G12, C52, C55

Suggested Citation

Garcia, Juan Angel and Werner, Sebastian, Bond Risk Premia, Macroeconomic Factors and Financial Crisis in the Euro Area (June 15, 2015). Louvain School of Management Working Paper Series No. 2015/14. Available at SSRN: https://ssrn.com/abstract=2670913 or http://dx.doi.org/10.2139/ssrn.2670913

Juan Angel Garcia

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Sebastian Werner (Contact Author)

Catholic University of Louvain (UCL) ( email )

Place Montesquieu, 3
Louvain-la-Neuve, 1348
Belgium

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