Published in:Banque de France Working Paper ; No. 352
Extent:
1 Online-Ressource (46 p)
Language:
English
DOI:
10.2139/ssrn.1966041
Identifier:
Origination:
Footnote:
Nach Informationen von SSRN wurde die ursprüngliche Fassung des Dokuments November 1, 2011 erstellt
Description:
In this paper, we propose a model of the joint dynamics of euro-area sovereign yield curves. The arbitrage-free valuation framework involves five factors and two regimes, one of the latter being interpreted as a crisis regime. These common factors and regimes explain most of the fluctuations in euro-area yields and spreads. The regime-switching feature of the model turns out to be particularly relevant to capture the rise in volatility experienced by fixed-income markets over the last years. In our reduced-form set up, each country is characterized by a hazard rate, specified as some linear combinations of the factors and regimes. The hazard rates incorporate both liquidity and credit components, that we aim at disentangling. The estimation suggests that a substantial share of the changes in euro-area yield differentials is liquidity-driven. Our approach is consistent with the fact that sovereign default risk is not diversifiable, which gives rise to specific risk premia that are incorporated in spreads. Once liquidity-pricing effects and risk premia are filtered out of the spreads, we obtain estimates of the actual – or real-world – default probabilities. The latter turn out to be significantly lower than their risk-neutral counterparts