eThesis - School of Business electronic theses

OBJECTIVE OF THE STUDY

The heavily increased government debt yield differentials and its impact on countries’ abilities to pay back their debts have gained enormous amount of public attention lately, but more recent studies have not succeeded in decomposing the reasons for the differentials comprehensively. In this thesis, I study the yield differentials of the Economic and Monetary Union (EMU) government bonds in relation to Germany. The objective of this study is to test the effects of domestic macroeconomic fundamentals and international factors on yield differentials. By examining the influence of these factors, the full impact of credit risk and its sources can be determined in detail. Furthermore, this study also gives an overview of various other, alternative factors potentially affecting the yield differentials.

DATA AND METHODOLOGY

The sample of factors affecting the government debt yields of selected EMU countries is extracted from Datastream and Eurostat. The data is collected from January 1993 to October 2011, and the frequency of the data is monthly. The study is conducted by using a relative asset swap model, which measures the credit riskiness of the countries by combining the country specific 10-year interest rate swaps and 10-year government bond yields. The impacts of domestic macroeconomic fundamentals and exogenous international risk factors are thus tested against the relative asset swap levels.

RESULTS

The impact of sole debt-to-GDP ratio is significant only for the newest EMU member state in this study, Slovenia. Slovenia is not affected by any other measure but the debt-to-GDP differential. The effect of exogenous risk factors as a function of debt-to-GDP differential in turn is significant for Austria, Belgium, Finland, Ireland, Italy and Portugal. In those cases, even though the international appetite for risk cannot be affected, these countries can diminish their yield differentials by improving their domestic fundamentals. Other factors were not found to significantly affect the yield differentials in the EMU area.