Sovereign bond yield spreads and market sentiment and expectations: Empirical evidence from Euro area countries

•We analyze the impact of behavioral factors on sovereign bond yield spreads in the Euro area.•The empirical analysis is based on a heterogeneous dynamic panel data approach.•Behavioral factors provide significant additional information on sovereign bond yield spreads.•Investor sentiment strongly contributes to widen sovereign spreads in times of heightened crisis.

The paper investigates the determinants of sovereign bond yield spreads in the Euro area and extends the models commonly used in empirical analyses by focusing on the impact of market expectations and behavioral factors.Using monthly panel data for ten European countries over the period 2000–2012, the analysis adopts a pooled mean-group approach to estimate non-stationary dynamic models of spreads determinants, allowing for country heterogeneities in short-run dynamics.Results show that the behavioral indicators considered, proxies of consumer and market sentiment and expectations, strongly affect spreads behavior, especially during the crisis. Specific attention is also paid to check the robustness of the estimated effects of behavioral indicators and to assess the impact of global financial crisis on the determinants of government bond rate differentials.