Working Paper: CEPR ID: DP7833
Authors: Stefan Gerlach; Alexander Schulz; Guntram B. Wolff
Abstract: We study the determinants of euro area sovereign bond spreads since the introduction of the euro. An aggregate risk factor is a main driver of spreads, both directly and indirectly by interacting with the size and structure of national banking sectors. When aggregate risk increases, countries with large banking sectors with low equity ratios experience greater widening in yield spreads, suggesting that financial markets perceive a larger risk that governments will have to rescue banks, increasing public debt and therefore sovereign risk. Moreover, government debt levels and forecasts of future fiscal deficits are also significant determinants of sovereign spreads.
Keywords: banking; EMU; liquidity; sovereign bond markets
JEL Codes: E43; E44; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| banking sector size (G21) | sovereign risk spreads (F34) |
| aggregate risk (E10) | marginal effect of banking sector size on sovereign spreads (F65) |
| equity-to-assets ratio (G32) | sovereign risk spreads (F34) |
| aggregate risk (E10) | equity-to-assets ratio effect on sovereign spreads (G32) |