Determinants of sovereign debt yield spreads under EMU: Pairwise approach

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