European Spreads at the Interest Rate Lower Bound

41 Pages Posted: 24 May 2017 Last revised: 19 Sep 2017

See all articles by Laura Coroneo

Laura Coroneo

University of York - Department of Economics and Related Studies

Sergio Pastorello

University of Bologna - Department of Economics

Date Written: September 18, 2017

Abstract

This paper analyzes the effect of the interest rate lower bound on long term sovereign bond spreads in the Euro area. We specify a joint shadow rate term structure model for the risk-free, the German and the Italian sovereign yield curves. In our model, the behavior of long term spreads becomes strongly nonlinear in the underlying factors when interest rates are close to the lower bound, which in the data occurs since the beginning of 2012. We fit the model by Quasi-Maximum Likelihood and highlight three important consequences of sovereign spreads’ nonlinear behavior: i) their distribution is skewed, ii) they are affected by (possibly exogenous) changes in the lower bound, and iii) they become less informative about the countries’ sovereign risk. Shadow spreads, however, still provide reliable information.

Keywords: lower bound, sovereign risk, shadow rate term structure model

JEL Classification: E43, E44, E52, G12

Suggested Citation

Coroneo, Laura and Pastorello, Sergio, European Spreads at the Interest Rate Lower Bound (September 18, 2017). Available at SSRN: https://ssrn.com/abstract=2973285 or http://dx.doi.org/10.2139/ssrn.2973285

Laura Coroneo (Contact Author)

University of York - Department of Economics and Related Studies ( email )

Heslington
York, YO1 5DD
United Kingdom

Sergio Pastorello

University of Bologna - Department of Economics ( email )

Via Saragozza, 8
Bologna, 40125
Italy
+39 051 2098144 (Phone)
+39 051 2098040 (Fax)

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