Sovereign bond yield spillovers in the Euro zone during the financial and debt crisis

In this paper we examine sovereign bond yield spread (BYS) spillovers between Euro zone countries during a turbulent period encompassing both the global financial crisis and the Euro zone debt crisis. Using the VAR-based spillover index approach of Diebold and Yilmaz (2012) and impulse response analyses, we find that: (i) on average, BYS shocks tend to increase future BYS, and are related to news announcements and policy changes; (ii) BYS spillovers between Euro zone countries are highly intertwined, however, BYS shocks from the periphery have, on average, three times the destabilising force on other countries than shocks coming from the core. (iii) The within-effect of BYS spillovers is of greater magnitude within the periphery than that within the core; (iv) The between-effect (core vs periphery) of BYS spillovers suggests directional spillovers of greater magnitude from the periphery to the Euro zone core than vice-versa. (v) Finally, joint shocks in the periphery and the core reveal decoupling effects between these two groups of countries. Overall, our findings highlight the increased vulnerability of the Euro zone from the destabilizing shocks originating mostly from the Euro zone countries in the periphery and to a lesser extent from the Euro zone core.