An update on EMU sovereign yield spread drivers in times of crisis: A panel data analysis

•We examine EMU sovereign bond yield spreads drivers using panel data techniques.•We use a broad set of fundamentals, market sentiment and risk aversion variables.•Sovereign risk in central countries is mainly related to regional fundamentals.•Market sentiment and investors’ risk aversion are relevant for peripheral countries.•The marginal effects of sovereign spread drivers increased during the crisis.

We empirically investigate the determinants of EMU sovereign bond yield spreads with respect to the German bund. Using panel data techniques, we examine the role of a wide set of potential drivers. To our knowledge, this paper presents one of the most exhaustive compilations of the variables used in the literature to study the behaviour of sovereign yield spreads and, in particular, to gauge the effect on these spreads of changes in market sentiment and risk aversion. We use a sample of both central and peripheral countries from January 1999 to December 2012 and assess whether there were significant changes after the outbreak of the euro area debt crisis. Our results suggest that the rise in sovereign risk in central countries can only be partially explained by the evolution of local macroeconomic variables in those countries. Besides, without exception, the marginal effects of sovereign spread drivers (specifically, the variables that measure global market sentiment) increased during the crisis compared to the pre-crisis period, especially in peripheral countries. Moreover, the increase in the significance of the banking level of indebtedness and foreign bank's claims in the public sector (mainly in peripheral countries) along with the crisis unfolding seems to highlight the interconnection between private and public debt and thus, between banking and sovereign crises.