Title: Dangerous liaisons? Debt supply and convenience yield spillovers in the euro area
Summary: This paper documents spillover effects of sovereign debt issuance among euro area countries’ convenience yields, establishing a new source of fiscal spillovers in the euro area
Authors: Cristian Arcidiacono (University of Bern), Matthieu Bellon (ESM), Matthias Gnewuch (ESM)
Abstract:
Many advanced economies sell sovereign bonds at a yield below the risk-free rate plus a default risk premium, benefiting from strong demand for safe assets. The literature shows that this “convenience yield” premium diminishes with bond supply but has focused on individual economies in isolation. In this paper, we investigate how a country’s convenience yield is affected by changes in another country’s supply of sovereign bonds. We collect debt issuance announcements and exploit high-frequency market reactions as well as heteroskedasticity around these events to quantify spillover effects. We find robust evidence that an increase in German debt reduces convenience yields across the euro area. Spillovers to low-risk countries are nearly one-for-one while those to riskier countries are weaker. Additional evidence from France confirms this pattern. We develop a model with multiple sovereigns and heterogeneous credit risk that rationalises our findings. Distinct but equally safe bonds are close substitutes to hedge against idiosyncratic income risk in recessions, explaining large spillovers, while risky bonds are poor substitutes. Our findings highlight a new source of fiscal spillovers among sovereign yields of low-risk countries.
Disclaimer: This Working Paper should not be reported as representing the views of the ESM. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the ESM or ESM policy. No responsibility or liability is accepted by the ESM in relation to the accuracy or completeness of the information, including any data sets, presented in this Working Paper.
Keywords: Convenience yield; spillovers; EMU; government debt; high-frequency identification; heteroskedasticity
JEL codes: E62; F36; G15; H63