Anticipated Macroeconomic Fundamentals, Sovereign Spreads and Regime-Switching : The Case of the Euro Area
Résumé
This paper provides evidence that forecasts in macroeconomic fundamentals can drive the changes observed in the sovereign bond spreads in a nonlinear fashion. More specifically, the impact of the anticipated macroeconomic variables on sovereign spreads depends upon the global conditions prevailing in the financial markets (appetite for risk, market liquidity, health of the banking sector). We use a nonlinear model of sovereign spreads, namely a time-varying probability Markov-switching model. The paper adds to the empirical literature by documenting that the strength with which changes in market expectations of economic fundamentals are factored in the determination of the Euro area bond market spreads is regime-dependent. Such dependence implies multiple “equilibrium relationships” between spreads and macroeconomic variables, and switches between the equilibria. We contribute to the literature by first proposing a simple analytical model in which some sources of regime switches are described. In particular, spreads are affected by the investors’ perceived probability of default on debt servicing by governments and this probability varies across time because investors anticipate the future outcome of macroeconomic fundamentals influencing sovereign debts. We then consider a reduced-form of the analytical model to illustrate the empirical performance of time-varying Markov-switching model in describing the experience of the euro area spread between 2003 and 2009.