How Euro-Area Sovereign Spreads Respond to Shocks? A TVP-FAVAR Model

38 Pages Posted: 15 Sep 2013

See all articles by Vassilios Babalos

Vassilios Babalos

Department of Accounting & Finance, Technological Educational Institute of Peloponnese; University of Piraeus - Department of Banking and Financial Management

Emmanuel C. Mamatzakis

University of Sussex - School of Business, Management and Economics

Date Written: September 13, 2013

Abstract

This paper examines the underlying dynamics of the Euro-area sovereign bonds most in need of fiscal consolidation by employing a Bayesian time varying parameter factor augmenting VAR (TVP-FAVAR thereafter) model. This methodology is applied for the first time and allows multivariate stochastic volatility. By doing so we identify the underlying response of Euro-area sovereign bonds spreads to shocks in several important factors, and in particular debt dynamics and credit risk. Deteriorating fiscal conditions appear to be the driving force behind high sovereign spreads and CDS. Significant evidence of volatility spikes in the sovereign debt markets is identified. The present study entails important implications for policy makers and enhances our understanding of market pricing mechanisms of default risk.

Keywords: credit risk, TVP-FAVAR, sovereign debt crisis, spreads, CDS

JEL Classification: G00, G01

Suggested Citation

Babalos, Vassilios and Mamatzakis, Emmanuel C., How Euro-Area Sovereign Spreads Respond to Shocks? A TVP-FAVAR Model (September 13, 2013). Available at SSRN: https://ssrn.com/abstract=2325613 or http://dx.doi.org/10.2139/ssrn.2325613

Vassilios Babalos (Contact Author)

Department of Accounting & Finance, Technological Educational Institute of Peloponnese ( email )

Antikalamos
Kalamata, KALAMATA 24100
Greece

HOME PAGE: http://www.teikal.gr

University of Piraeus - Department of Banking and Financial Management ( email )

80 Karaoli & Dimitriou Str.
18534 Piraeus, 185 34 -GR
Greece

Emmanuel C. Mamatzakis

University of Sussex - School of Business, Management and Economics ( email )

Falmer, Brighton BN1 9SL
United Kingdom

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