Expectations and term premia in EFSF bond yields
37 Pages Posted: 11 Aug 2022
Date Written: July 29, 2022
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: Suggested Citation