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Recently the world economy was confronted to the worst financial crisis since the great depression. This unprecedented crisis started in mid-2007 had a huge impact on the European government bond market. But what are the main drivers of this “perfect storm” that since 2009 affects EU government bond market as well? To answer this question, we propose an empirical study of the determinants of the sovereign bond spreads of EU countries with respect to Germany during the period 2003–2010. Technically, we address two main questions. First, we ask what share of the change in sovereign bond spreads is explained by changes in the fundamentals, liquidity, and market risks. Second, we distinguish between EU member states within and outside the Euro area and question whether long-term determinants of spreads affect EU members uniformly. To these ends, we employ panel data techniques in a regression model where spreads to Germany (with virtually no default risk) are explained by set of traditional variables and a number of policy variables. Results reveal that large fiscal deficits and public debt as well as political risks and to a lesser extent the liquidity are likely to put substantial upward pressures on sovereign bond yields in many advanced European economies.

The growth in euro-denominated bond debt issued by emerging market sovereigns picked up considerably after the Asian currency crises. However, while many emerging market governments now have outstanding euro-denominated issues, the market for this debt remains considerably smaller and less liquid than its US dollar counterpart. This has implications for both investors and sovereigns as they try to balance liquidity and cost of capital considerations against portfolio diversification and exchange rate movements. Broadly speaking, spreads on emerging market bonds across countries tend to move in tandem over time. This chapter takes an introductory look at the market for euro-denominated sovereign debt, and investigates the degree to which spreads on euro-denominated emerging market sovereign debt react to common forces. Following a similar analysis of the US dollar market in McGuire and Schrijvers (2003) (hereafter MS2003), we use principal factor analysis to determine the number of common factors that drive movements in spreads, and then seek to assign meaning to these factors through simple correlations with economic variables.

The expanded sovereign bond portfolios from the sizeable public interventions in the financial sector during the current crisis need close monitoring and analysis of emerging vulnerabilities. This chapter presents some conventional and new measures of market, credit, and liquidity risks for government bond portfolios, considered from the perspective of a sovereign debt manager. In particular, it examines duration, convexity, and VaR statistics as measures of market exposure; the contingent-claims approach as the most promising measure of credit risk exposure; and a VaR statistic as a measure of liquidity risk.

Emerging-market (EM) assets have historically been regarded as inherently risky and particularly vulnerable to international shocks that result in a general increase in investor risk perceptions. In this chapter, we assess the ongoing relevance of this view by examining the linkages between EM and non-EM stock and bond markets in the past two decades, with a focus on how these relationships played out during the global financial crisis of 2007–2009. We evaluate how these linkages have evolved over the period 1992–2009, through statistical tests of whether the volatility of EM financial markets changed – either in their response to international shocks originating in advanced-economy markets or in their independent fluctuations.

We find that over a longer period EM, bond and stock prices have on average moved in the same direction as the prices of non-EM risky assets, and this co-movement has persisted. However, these relationships have evolved somewhat over time. Both EM sensitivity to international shocks and EM-specific volatility in EM sovereign-bond spreads appear to have decreased over time, consistent with the greater fundamental stability of EM economies and perhaps a reduced inclination by investors to sell off EM assets in response to a rise in risk perceptions. Somewhat in contrast, while an upward trend in co-variation between EM and non-EM stock prices suggests an increasing degree of global market integration, idiosyncratic volatility has declined, consistent with a diminished level of locally driven risk in these markets.

In addition, the response of EM asset prices to the latest financial crisis appears to be moderate in comparison to historical experience. This evidence may reflect reduced EM vulnerability to external shocks in general, which is consistent with some encouraging improvements in the underlying fundamentals of EM economies over the decade preceding the onset of the crisis.

This chapter reassesses the economics of interest rate risk management in light of the global financial crisis by developing a derivative-based integrated treatment of interest rate and credit risk interrelation. The decade-long historical data on credit default swap spreads and interest rate swap rates are used as proxy measures for credit risk and interest rate risk, respectively. An elasticity of interest rate risk and credit risk, considered a function of the business cycle phases, maturity of instruments, economic sector, creditworthiness, and other macroeconomic parameters, is investigated for optimizing economic capital. This chapter sheds light on how financial institutions may address hedge strategies against downside risks implementing the proposed derivative-based integrated treatment of interest rate and credit risk assessment allowing for optimization of interest rate swap contracts. The developed framework of integrated interest rate and credit risk management is of special importance for emerging markets heavily dependent on foreign capital as it potentially allows emerging market banks to improve risk management practices in terms of capital adequacy and Basel III rules. Analyzing diversification versus compounding effects, it allows enhancing financial stability through jointly optimizing Pillar 1 and Pillar 2 economic capital.

In the euro’s initial years, Greece, Ireland, Italy, Portugal and Spain observed capital flow bonanzas and credit-booms, two cycles known to precede banking crises. Domestic banks fuelled those cycles via funding obtained from foreign financial institutions. Yet, these countries’ banking and financial crises have unfolded in different modes. In Ireland and Spain, credit-booms propelled real-estate bubbles, which dragged banks into crises, with governments’ accounts later being affected when rescuing banks (Spanish regional banks, and all Irish major banks). In Greece and Italy, extra monetary means perpetuated government imbalances (e.g. debt levels above 100% of GDP, large yearly deficits). More severely in Greece, banks were brought into crises by sovereign crises. In Portugal, a mixture of private and public sector–led crises have occurred. Our comparative study finds that these crises: (1) are connected to shocks and imbalances caused by dangerous banking sector cycles during the monetary integration process; (2) were not mere expansions of the US subprime crisis; (3) were not only caused by country-specific features and institutions; and (4) followed distinct paths, therefore, a uniform model encompassing all post-euro crises cannot exist.

Inefficiencies in the fiscal and monetary systems of the Ottoman Empire led to a higher debt burden over time and the bankruptcy for the Ottoman state in 1875. To deal with these inefficiencies, reforms were implemented: supervisory organizations were established and the gold standard was adopted. How did investors at the Istanbul Bourse view these reforms? We manually collected data on the price of Ottoman government bonds on the Bourse from 1873 to 1883. Using the generalized autoregressive conditional heteroscedasticity (GARCH) methodology, we identify short-run and permanent changes in volatility of bond returns subsequent to the reforms. Our results suggest investors responded positively, by accepting lower yield premia, to adoption of the gold standard, and foundation of the Ottoman Public Debt Administration which had European sponsors, but did not respond positively to reforms that relied on purely local institutions.

This paper investigates the European Central Bank’s (ECB) monetary policies. It identifies an anti-growth bias in the ECB’s monetary policy approach: the ECB is quick to hike, but slow to ease. Similarly, while other players and institutional deficiencies share responsibility for the euro’s failure, the bank has generally done “too little, too late” with regard to managing the euro crisis, preventing protracted stagnation, and containing deflation threats. The bank remains attached to the euro area’s official competitive wage repression strategy which is in conflict with the ECB’s price stability mandate and undermines the bank’s more recent unconventional monetary policy initiatives designed to restore price stability. The ECB needs a “Euro Treasury” partner to overcome the euro regime’s most serious flaw: the divorce between central bank and treasury institutions.

The currency premium is one of the three components of the differential between local and foreign interest rates. Emerging economies such as South Africa typically face positive interest rate differentials, that is, a higher cost of capital than developed economies. In this chapter we aim at identifying the determinants of the South African rand–U.S. dollar currency premium using monthly data over the period 1997–2008. We carry out an empirical analysis using dynamic time series econometric techniques to estimate the determinants of the one-month and one-year currency premia. Our findings show that the currency premia at both horizons are driven by long-run movements in the expected inflation differential between South Africa and the United States, risk aversion as a proxy for the price of rand exchange risk, and the volatility of the rand exchange rate as an indicator of the quantity of that risk. Misalignments in the real effective or rand–U.S. dollar bilateral exchange rates display mixed results in terms of their impact and statistical significance on both currency premium. Our parameter estimators overall are stable and robust to sample variations. Monetary policy is an important determinant of currency premia at both one-month and one-year horizons, but risk aversion is equally important to determine its time fluctuations.

This study aimed to know the effect of cross-sectional risk, which comprises business-specific risk and stock market volatility, as a variable for estimating macroeconomic risk in Indonesia. This study observes public companies in Indonesia and Indonesian macroeconomic data from 2004 to 2020. In this study, the author uses term spread as the dependent variable that reflects macroeconomic risk. The cross-sectional risk comprises financial friction (FF), cash flow (CF), debt–service ratio, and stock market volatility as independent variables. By using the Autoregressive Distributed Lag (ARDL) Model method, this study shows that business-specific and stock market risk can estimate macroeconomic risk, so that it becomes an early signal of economic shock, such as recession or high inflation, in the future. The model in this study also examines the cross-sectional risk relationship with other macroeconomic indicators, such as the Consumer Confidence Index (CCI), money supply (M0), and Indonesia’s trade balance (TB).