Determinants of sovereign debt yield spreads under EMU: Pairwise approach

This study aims at providing an empirical analysis of long-term determinants of sovereign debtyield spreads under European EMU (Economic and Monetary Union) through pairwise approachwithin panel framework. Panel gravity models are increasingly used in the cross-marketcorrelation literature while to our knowledge, this is the first empirical study employing themethod in the bond market literature. Accordingly, sovereign yield spreads are positively relatedto differential government debt ratio while negatively related to relative economic growthperformance, differential liquidity of the individual debt markets as well as governance quality.Moreover, non-linear dynamic panel estimates indicate that markets seem to ignore fundamentalsafter the emerge of EMU while the very same risk factors are revalued by the markets afterthe 2008/2009 financial crisis. Furthermore, markets price fiscal indebtedness more among theEMU members than among the non-EMU members. Finally, the results of the dynamic panelmodel are robust to different estimation techniques such as GMM as well as sample selection.