Finance Research Letters xxx (2014) xxx–xxx

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Finance Research Letters

journal homepage: www.elsevier .com/locate/fr l

Long-term government bond yields andmacroeconomic fundamentals: Evidence forGreece during the crisis-era

http://dx.doi.org/10.1016/j.frl.2014.02.0031544-6123/� 2014 Elsevier Inc. All rights reserved.

⇑ Corresponding author. Tel.: +30 6946905951.E-mail addresses: dchionis@ierd.duth.gr (D. Chionis), gpragkid@ierd.duth.gr (I. Pragidis), Panagiotis.Schizas@g

(P. Schizas).1 Tel.: +30 2531039827.

Please cite this article in press as: Chionis, D., et al. Long-term government bond yields and macroecfundamentals: Evidence for Greece during the crisis-era. Finance Research Letters (2014), http://dx.d10.1016/j.frl.2014.02.003

Dionysios Chionis a,1, Ioannis Pragidis a,⇑, Panagiotis Schizas b

a Department of Economics, Democritus University of Thrace, Greeceb Department of Economics, Democritus University, Komotini, Greece

a r t i c l e i n f o

Article history:Received 5 December 2013Accepted 8 February 2014Available online xxxx

JEL classification:G12G14E43E44

Keywords:Sovereign bondsMacroeconomic fundamentalsGreek Debt Crisis

a b s t r a c t

This paper studies the influence of macroeconomic fundamentalsand the underlying 10 years Greek government bonds. We exam-ine for the period between Q12001 up to end to Q42012, applyingfour major macroeconomic variables such as Debt to GDP ratio,deficit, inflation and unemployment. We found that, overall, deficit,inflation and unemployment among others, play a more significantrole as determinants of the 10-year Greek bond yield, while isolat-ing the period during the crisis macroeconomic factors strengthentheir affect to the Greek Debt market.

� 2014 Elsevier Inc. All rights reserved.

1. Introduction

The recent crisis of the Sub-primes caused a solvency crisis on investors risk perception on the via-bility of Euro zone countries. As a result, the international capital markets were the driven force sincepoliticians were taking under consideration their reaction before any policy-decision taken. Further-more, for the first time in the history, a country, into a common currency, applies for an international

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2 D. Chionis et al. / Finance Research Letters xxx (2014) xxx–xxx

bail-out and accepts fiscal austerity measures, which demand currency depreciation in order to beeffective and successive. Under this spectrum it is crucial to examine if the macro fundamentals werethe main determinants of the Greek bond yields, during the pre- and post-crisis era.

The first upward trend in Greek spreads began to appear in 2008 as international markets were inupheaval. Thus, from 35 basis points (bps) in that period, the Greek government spreads amounted to230 bps in December of 2008, while in March of 2009 ranged to 300 bps. The first signs of the crisis inthe Greek bond’s market are placed on 10 October of 2009 following the announcement of the GreekGovernment for an upward revision of it is estimated budget deficit for the year 2009 initially from 7%to 12%, and finally at 15.6% of GDP. Fitch rating agency in December of that year downgraded theGreek economy from the category A� to BBB+. It was the first time in a period of 10 years that theGreek economy was downgraded.

Existing Literature addresses contradicting evidences regarding the main drivers of governmentbond yields. On the one hand, many authors argue that a country’s macroeconomic fundamentals suchas Debt to GDP ratio, deficit, current account deficit, and unemployment are the primary determinantsof government bond yields (Bernoth et al., 2004; Pagano and von Thadden, 2004; Georgoutsos andMigiakis, 2012; Sosvilla-Rivero and Morales-Zumaquero, 2012). On the contrary, many authors(Schuknecht et al., 2010; Mody, 2009; Longstaff et al., 2011) find empirical evidences against countryspecific macroeconomic fundamentals and argue that common factors such as a generalised risk aver-sion factor affects government bond yields. In conjunction with the above, there is a class of papersthat attribute the overwhelming increase of sovereign spreads of the Southern countries in EU notsolely to their macroeconomic fundamentals but to a time factor which drives bond’s spreads upand it is related to the weakness of EU countries to conduct independent monetary policy (DeGrauweand Ji, 2013).

The rest of the paper is organised as follows: Section 2 includes the data and the empirical meth-odology used. In Section 3 are presented the empirical results and Section 4 concludes.

2. Data and empirical methodology

The sample consists of quarterly data on sovereign bond yields and their fundamental determi-nants for the period 2001–2012 for the Greek economy. The data span represents the evolution ofthe yield of the Greek bond market by the entrance of Greece to Euro through the decade, extendedthrough the period of the tremendous crisis. Estimations have been splitted up into 2 different periods.The first period included the entire data span (1Q2001–4Q2012) – Euro Era and the second period isconcentrated only on the abnormal period of the crisis (2Q2009–4Q2012).

Figs. 1 and 2 show the dynamics of sovereign bond yields and the most significant determinants ashave been examined by the existing literature and have been applied to this existing work. Fig. 1clearly, shows the abnormalities in Greek bond yields, and Fig. 2, defines that the General Govern-ments Deficit and Growth found to be the most closed to their theoretical distribution. More precisely,

-8

-4

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4

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24

0 5 10 15 20 25 30 35Quantiles of YIE

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Fig. 1. The figure plots Quantile–Quantile distribution of the Greek Bond Yields, for January 2001 to December 2012.

Please cite this article in press as: Chionis, D., et al. Long-term government bond yields and macroeconomicfundamentals: Evidence for Greece during the crisis-era. Finance Research Letters (2014), http://dx.doi.org/10.1016/j.frl.2014.02.003

60

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80 100 120 140 160 180

Quantiles of DEBT1

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DEBT1

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2 4 6 8 10 12 14 16

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Quantiles of CDS_10Y

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GREECE/10Y SENIOR OLDRE/ SPREAD/NYCLOSE

Fig. 2. The figure plots Quantile–Quantile distribution of the four bond yield fundamental determinants – Debt/GDP ratio,General Government Deficit, growth and 10 year CDS index, for January 2001 to December 2012.

D. Chionis et al. / Finance Research Letters xxx (2014) xxx–xxx 3

the determinants are: changes in the primary balance ratio (short-term fiscal policy) and changes inthe growth rate (cyclical fluctuations).

As Table 1 below indicates due to the presence of a unit root in levels we transform our data to theirrate of returns as these are free of a unit root.

Eq. (1) introduces the empirical models used to capture to what extent the dramatic movements ingovernment bond spreads occurred in the euro area in the last years are due to fundamental factors(as proxied by the countries fiscal position and other macroeconomic indicators).

Table 1The tab

YieldInflaUnemGGBGrow

Note: Tformula⁄, ⁄⁄,⁄⁄⁄

Pleasefunda10.101

Drt ¼ b0 þ b1DInft þ b2DUnemt þ b3DGGBt þ b4DGrowtht þ et ð1Þ

le represents the augmented Dickey–Fuller test of unit root.

H0: I(1) H0: I(1)

Levels prob. Change prob.

0.33 0.00⁄⁄⁄

tion 0.96 0.00⁄⁄⁄

ployment 0.21 0.03⁄⁄

0.36 0.03⁄⁄

th 0.34 0.0.0⁄⁄⁄

he change in the 3rd column denotes the transformation of the variables into their rate of returns according to the: Change(xt) = (xt � xt�1)/xt�1, as used in Eq. (1).

Denote a rejection of the null hypothesis at the 10%, 5% and 1% level of significance respectively.

cite this article in press as: Chionis, D., et al. Long-term government bond yields and macroeconomicmentals: Evidence for Greece during the crisis-era. Finance Research Letters (2014), http://dx.doi.org/6/j.frl.2014.02.003

4 D. Chionis et al. / Finance Research Letters xxx (2014) xxx–xxx

In (1) Drt is the change in the bond yield, t denotes time, and et is an i.i.d. error term and includesonly the Macroeconomic Variables. Following the relevant literature, up to five Long-run determinants(LR) is also included: changes in Inflation (DInf) and changes in Unemployment (DUnem) (nominalshocks), changes in the Primary Balance ratio and changes in General Government balance ratio(DGGB) (Long-term fiscal policy) and changes in the growth rate (DGrowth) (cyclical fluctuations).

3. Baseline results on macro fundamentals

Table 2 presents the relationship between the changes in the bond yields and their fundamentalmacro factors for the Euro-Era (Panel A) and for the isolated period of the crisis (Panel B) of Eq. (1).First, in line with the economic rationale, the long-run coefficients of the unemployment and inflationfound to be significant for both periods (Poghosyan, 2012), suggesting that crisis did not change thedeterminants of bond yields. The degree of influence for unemployment increase significantly from1.39 to 10.24 during the crisis. The same behaviour is observed between the Greek bond yields andInflation. During the crisis, inflation turns to accelerate the speed of adjustment coefficient increasesfrom 0.12 to 0.21.

The not significant coefficient of the growth variable, during the Euro Era, suggests a surprise sincethe literature shows that faster growing countries pay higher interest rate. It is noteworthy that thegrowth rate did not affect the perception of investors in Greek bonds. During the crisis, the most pop-ular factor, found to be the General Governments Balance (Deficit). The latter finding is crucial sincethe start of the crisis up and one of the main factors that lead Greek bond off to tap the market. Eventhough the markets did not pay any attention to the deficit the last decade, indeed, was the key factorduring the crisis (Bernoth and Erdogan, 2012; Afonso et al., 2012). The impact of the deficit has signif-icant coefficient and expected sign. As not expected, the Greek bond yields found not to be affected bythe growth rate, even during the bubble and after the burst of it. Indeed, this finding is alighted withthe literature, as the changes in the real growth rate and the primary balance ratio found to beinsignificant.

As expected, changes in bond yields are positively affected by changes in Unemployment and bychanges in Inflation (Poghosyan, 2012; Bengoechea, 2012). The latter finding can be interpreted as a sur-prise effect, as short-run changes in inflation in excess of expectations result in a temporary decline ofbond yields. This finding is in line with recent euro area studies (e.g., DeGrauwe and Ji, 2013), which showthat markets underestimated the impact of fundamentals when pricing sovereign bond yields in euro areacountries in the period following the introduction of the euro and up to the eruption of the crisis.

The non-significant behaviour between the change in growth momentum and 10 years Greek BondYields, has to do with the fact that the forced liquidation from Greek bonds are not associated with theability to debt servicing, as known to a deficit economy, investors give basis the numerator of theindex.

Table 2The table represents the empirical OLS estimations of Greek Bond Yields. The estimations are extended from January 2001 toDecember 2012, applying quarterly data to Eq. (1), segmented into two periods. The corresponding p-values are reported for eachseparate variable and statistics are corrected for autocorrelation and heteroscedasticity using Newey–West estimator with 2 lags.

Macro

Intercept Unemployment Growth Inflation Deficit change

Panel AEuro era 0.013 1.390⁄⁄ �0.017 0.124⁄⁄⁄ �0.080

(0.509) (0.012) (0.111) (0.000) (0.805)

Panel BCrisis �0.660⁄⁄⁄ 10.240⁄⁄⁄ 0.043 0.211⁄⁄⁄ 0.990⁄⁄

(0.001) (0.000) (0.256) (0.001) (0.015)

Note: p-Values presented in parentheses; the p-values of the Breusch–Godfrey test for serial correlation are 0.25 and 0.16 forPanel A and Panel B respectively indicating no autocorrelation.⁄, ⁄⁄, ⁄⁄⁄ Denote a rejection of the null hypothesis at the 10%, 5% and 1% level of significance respectively.

Please cite this article in press as: Chionis, D., et al. Long-term government bond yields and macroeconomicfundamentals: Evidence for Greece during the crisis-era. Finance Research Letters (2014), http://dx.doi.org/10.1016/j.frl.2014.02.003

D. Chionis et al. / Finance Research Letters xxx (2014) xxx–xxx 5

To sum up, most of the macro variables have significant coefficients and expected signs. With nodoubt, it is remarkable finding that during the crisis the change in the growth rate does not look tobe in the factors leering investors (this finding is in opposite direction as Poghosyan’s, 2013). Thecurrent account balance, was among the top determinants of the Greek bond yields, only for the periodduring the crisis.

4. Conclusion

The empirical analysis supports the existence of a structural break due to macro fundamentals ofthe yield function. During the time before memorandum, Inflation and Unemployment both seem sig-nificant determinants for the yield. Immediately after the burst of the Greek crisis in addition to thebefore mentioned factors a new factor seems to be significant, that is the fiscal deficit while growthrate has not any significant impact on the yield. This implies that the policy option of the fiscal con-solidation is the appropriate road map for Greece to come back to the international capital markets.On the contrary, a positive growth rate without any decrease in unemployment cannot lead the Greeceto exit to the international markets. A quite interesting result is that during the crisis period half of thedeviation of bond yields from their long-run equilibrium level adjusts during abnormal periods whichadjustment well exceeds the before crisis relative coefficient. This increase, confirms the sell-off thattook place in Greek fixed income market.

Acknowledgment

This research has been co-financed by the European Union (European Social Fund – ESF) and Greeknational funds through the Operational Program ‘‘Education and Lifelong Learning’’ of the NationalStrategic Reference Framework (NSRF) - Research Funding Program: THALES. Investing in knowledgesociety through the European Social Fund.

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Please cite this article in press as: Chionis, D., et al. Long-term government bond yields and macroeconomicfundamentals: Evidence for Greece during the crisis-era. Finance Research Letters (2014), http://dx.doi.org/10.1016/j.frl.2014.02.003