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Bond Yield Compression in the Countries Converging to the Euro

32 Pages Posted: 8 May 2006  

Lucjan T. Orlowski

Sacred Heart University - John F. Welch College of Business

Kirsten Lommatzsch

German Institute for Economic Research (DIW Berlin)

Date Written: October 2005

Abstract

We demonstrate that bond yield compression is under way in the countries converging to the euro and that German yields are significant drivers of local currency yields. Based on the evidence from Poland, Hungary and the Czech Republic, we conclude that these new Member States of the European Union are ready to adopt the euro without risking a disruptive shock to their financial stability. This message transpires from investigating the daily volatility dynamics of local bond yields as a function of German yields, conditional on changes in local term spreads, exchange rates and adjustments to central bank reference rates. Similar results of high sensitivity of local currency bond yields to changes in German yields are obtained from testing monthly series of macroeconomic fundamentals. These findings provide evidence of the potential usefulness of term spreads as indicators of monetary convergence.

Keywords: term spread, term premium, yield compression, monetary convergence, new Member States, EMU, conditional volatility, asymmetric GARCH models

JEL Classification: E43, E44, F36

Suggested Citation

Orlowski, Lucjan T. and Lommatzsch, Kirsten, Bond Yield Compression in the Countries Converging to the Euro (October 2005). William Davidson Working Paper No. 799. Available at SSRN: https://ssrn.com/abstract=897964 or http://dx.doi.org/10.2139/ssrn.897964

Lucjan T. Orlowski (Contact Author)

Sacred Heart University - John F. Welch College of Business ( email )

5151 Park Avenue
Fairfield, CT 06825
United States
203-371-7858 (Phone)

HOME PAGE: http://www.sacredheart.edu/ltorlowski.cfm

Kirsten Lommatzsch

German Institute for Economic Research (DIW Berlin) ( email )

Mohrenstra├če 58
Berlin, 10117
Germany

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