Determinants of sovereign bond yield spreads and contagion in the peripheral EU countries

This paper investigates the contagion effects in the daily bond yield spreads (relative to Germany) of five peripheral EU countries including Portugal, Italy, Ireland, Greece and Spain, as a consequence of the recent euro-debt crisis, by employing a robust semiparametric copula method. Furthermore, we model both the means and volatilities of daily bond yield spreads in terms of potential determinants. By doing so, we obtain “other effects” free sovereign bond spreads, which together with the robust copula method would correctly uncover the core contagion, when present. The empirical results indicate that the German stock index return, the Euro Interbank Offered Rate, stock index returns of these countries, S&P 500 returns, VIX and sovereign debt ratings have had significant impacts on the bond yield spreads and/or volatilities, particularly in the post-crisis period. We find overwhelming evidence of financial contagion effects among the peripheral countries. The two large countries Spain and Italy appear to be operating independent of each other, whereas Ireland, Greece and Portugal are found to be the exporters of contagion. In globally interconnected financial markets, central bankers and policy makers are concerned about contagion, through which the crisis proliferates around the region and beyond, triggering instability in the financial markets. Thus, our findings have implications for international policy debate, debt crisis risk management and financial market participants.