Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/79460
Authors: 
Apergis, Nicholas
Mamatzakis, Emmanuel
Year of Publication: 
2012
Series/Report no.: 
Working Paper, Levy Economics Institute 720
Abstract: 
This paper examines the underlying dynamics of selected euro-area sovereign bonds by employing a factor-augmenting vector autoregressive (FAVAR) model for the first time in the literature. This methodology allows for identifying the underlying transmission mechanisms of several factors; in particular, market liquidity and credit risk. Departing from the classical structural vector autoregressive (VAR) models, it allows us to relax limitations regarding the choice of variables that could drive spreads and credit default swaps (CDSs) of euro-area sovereign debts. The results show that liquidity, credit risk, and flight to quality drive both spreads and CDSs of five years' maturity over swaps for Greece and Ireland in recent years. Greece, in particular, is facing an elastic demand for its sovereign bonds that further stretches liquidity. Moreover, in current illiquid market conditions spreads will continue to follow a steep upward trend, with certain adverse financial stability implications. In addition, we observe a negative feedback effect from counterparty credit risk.
Subjects: 
Sovereign Debt Crisis
Spreads
CDS
FAVAR Model
Greece and Ireland
JEL: 
C32
G00
G01
Document Type: 
Working Paper

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