Paper presented at the 54th Panel Meeting of Economic Policy in October 2011. We thank our discussant Thorsten Beck, two anonymous referees, Massimo Florio, Bruno Usai and Yian Ma of Mako Investments for their helpful comments.
Sovereign spreads in the eurozone: which prospects for a Eurobond?
Article first published online: 4 APR 2012
© CEPR, CES, MSH, 2012
Volume 27, Issue 70, pages 231–273, April 2012
How to Cite
Favero, C. and Missale, A. (2012), Sovereign spreads in the eurozone: which prospects for a Eurobond?. Economic Policy, 27: 231–273. doi: 10.1111/j.1468-0327.2012.00282.x
The Managing Editor in charge of this paper was Philip Lane.
- Issue published online: 4 APR 2012
- Article first published online: 4 APR 2012
In this paper, we provide new evidence on the determinants of sovereign yield spreads and ‘market sentiment’ effects in the eurozone in order to evaluate the rationale for a common Eurobond jointly guaranteed by eurozone Member States. We find that default risk is the main driver of yield spreads, suggesting small gains from greater liquidity. Fiscal fundamentals matter in the pricing of default risk but only as they interact with other countries’ yield spreads; that is, with the global risk that the market perceives. More importantly, the impact of this global risk variable is not constant over time, a clear sign of contagion driven by shifts in market sentiment. This evidence points to a discontinuity in the disciplinary role of financial markets. If markets can stay irrational longer than a country can stay solvent, then the role of yield spreads on national bonds as a fiscal discipline device is considerably weakened, and issuing Eurobonds can be economically justified.
— Carlo Favero and Alessandro Missale