This paper studies the influence of macroeconomic fundamentals and the underlying 10 years Greek government bonds. We examine for the period between Q12001 up to end to Q42012, applying four 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 significant role as determinants of the 10-year Greek bond yield, while isolating the period during the crisis macroeconomic factors strengthen their affect to the Greek Debt market.
The recent crisis of the Sub-primes caused a solvency crisis on investors risk perception on the viability of Euro zone countries. As a result, the international capital markets were the driven force since politicians were taking under consideration their reaction before any policy-decision taken. Furthermore, for the first time in the history, a country, into a common currency, applies for an international bail-out and accepts fiscal austerity measures, which demand currency depreciation in order to be effective and successive. Under this spectrum it is crucial to examine if the macro fundamentals were the 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 in upheaval. Thus, from 35 basis points (bps) in that period, the Greek government spreads amounted to 230 bps in December of 2008, while in March of 2009 ranged to 300 bps. The first signs of the crisis in the Greek bond’s market are placed on 10 October of 2009 following the announcement of the Greek Government 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 the Greek economy from the category A− to BBB+. It was the first time in a period of 10 years that the Greek economy was downgraded.
Existing Literature addresses contradicting evidences regarding the main drivers of government bond yields. On the one hand, many authors argue that a country’s macroeconomic fundamentals such as Debt to GDP ratio, deficit, current account deficit, and unemployment are the primary determinants of government bond yields (Bernoth et al., 2004, Pagano and von Thadden, 2004, Georgoutsos and Migiakis, 2012 and Sosvilla-Rivero and Morales-Zumaquero, 2012). On the contrary, many authors (Schuknecht et al., 2010, Mody, 2009 and Longstaff et al., 2011) find empirical evidences against country specific macroeconomic fundamentals and argue that common factors such as a generalised risk aversion factor affects government bond yields. In conjunction with the above, there is a class of papers that attribute the overwhelming increase of sovereign spreads of the Southern countries in EU not solely to their macroeconomic fundamentals but to a time factor which drives bond’s spreads up and it is related to the weakness of EU countries to conduct independent monetary policy (DeGrauwe and Ji, 2013).
The rest of the paper is organised as follows: Section 2 includes the data and the empirical methodology used. In Section 3 are presented the empirical results and Section 4 concludes.
The empirical analysis supports the existence of a structural break due to macro fundamentals of the yield function. During the time before memorandum, Inflation and Unemployment both seem significant determinants for the yield. Immediately after the burst of the Greek crisis in addition to the before mentioned factors a new factor seems to be significant, that is the fiscal deficit while growth rate has not any significant impact on the yield. This implies that the policy option of the fiscal consolidation 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 Greece to exit to the international markets. A quite interesting result is that during the crisis period half of the deviation of bond yields from their long-run equilibrium level adjusts during abnormal periods which adjustment well exceeds the before crisis relative coefficient. This increase, confirms the sell-off that took place in Greek fixed income market.
