Expectations and term premia in EFSF bond yields

37 Pages Posted: 11 Aug 2022

See all articles by Andrea Carriero

Andrea Carriero

Queen Mary, University of London; University of Bologna

Lorenzo Ricci

European Stability Mechanism

Elisabetta Vangelista

European Stability Mechanism

Date Written: July 29, 2022

Abstract

The European Financial Stability Facility (EFSF) was set up in June 2010 as a temporary crisis resolution mechanism. In October 2012, its tasks were taken over by European Stability Mechanism (ESM), a permanent institution with a capital-based structure. Liquidity conditions for EFSF bonds in the secondary market are different from those of large sovereign bond issuers, which affects bond pricing. This paper offers the first study of the term structure of EFSF bond yields and a decomposition into expected interest rates and risk premia, based on a state-of-the-art no-arbitrage term structure model. A joint model of the EFSF curve and the swap curve allows to further identify the liquidity and credit components of both yield curves and disentangle an additional element of liquidity typical of bonds. This component is closely related to the ECB monetary policy. This model can be extended to other supranational institutions.

Keywords: Term structure, volatility, density forecasting, no arbitrage

JEL Classification: C32, C53, E43, E47, G12

Suggested Citation

Carriero, Andrea and Ricci, Lorenzo and Vangelista, Elisabetta, Expectations and term premia in EFSF bond yields (July 29, 2022). European Stability Mechanism Working Paper No. 54, Available at SSRN: https://ssrn.com/abstract=4187872 or http://dx.doi.org/10.2139/ssrn.4187872

Andrea Carriero

Queen Mary, University of London ( email )

Mile End Road
London, London E1 4NS
United Kingdom

University of Bologna ( email )

Piazza Scaravilli 2
Bologna, 40100
Italy

Lorenzo Ricci (Contact Author)

European Stability Mechanism ( email )

6a Circuit de la Foire Internationale
L-1347
Luxembourg

Elisabetta Vangelista

European Stability Mechanism

6a Circuit de la Foire Internationale
L-1347
Luxembourg

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