Investor sentiment and yield spread determinants: evidence from European markets
Abstract
Purpose
This paper aims to investigate the yield spread determinants for a sample of European markets in the light of the recent financial crisis. It utilises findings from two different strands in the literature: findings on bond spread determinants and findings on the effect of investor sentiment on equity returns.
Design/methodology/approach
The explanatory variables in the regression models proxy not only for economic fundamentals (e.g. economic activity, default risk, liquidity risk, general market conditions) but also for investor sentiment. A vector autoregressive approach is employed.
Findings
The results indicate that fundamental variables are significant for the determination of the level of yield spreads, as suggested by previous studies. Local and international investor sentiment, however, both current and past, is also a statistically significant determinant for both the level and monthly changes of yield, especially during the crisis period 2007-2011.
Research limitations/implications
The implication of this finding is significant for all parties involved: government officials, private lenders, EU/ECB/IMF officials, and market participants.
Practical implications
Focusing solely on quantitative economic performance indicators may not have the desirable effect of reducing borrowing rates and facilitating the return to economic stability. Perhaps, reassuring and/or sending strong qualitative signals to financial markets may be as important. Involved agents may have to address not only technical financial issues but also the perception that market participants have about the proposed solutions to the crisis and eventually affect market sentiment.
Originality/value
The issue of the effect of investor sentiment on government yield spreads during a crisis has not been investigated before.
Keywords
Acknowledgements
JEL classifications – J14, J15. Spyros Spyrou acknowledges financial support from the Research Centre at Athens University of Economics and Business (RC-AUEB).
Citation
Spyrou, S. (2013), "Investor sentiment and yield spread determinants: evidence from European markets", Journal of Economic Studies, Vol. 40 No. 6, pp. 739-762. https://doi.org/10.1108/JES-01-2012-0008
Publisher
:Emerald Group Publishing Limited
Copyright © 2013, Emerald Group Publishing Limited