Interest rate spreads in the eurozone: Fundamentals or sentiments?

Abstract

We analyze the determinants of interest rates on long-term government bonds within the eurozone to assess whether the recent divergence in interest rates is attributable to changes in common economic fundamentals. First, we argue that the panel regression approach commonly employed in existing literature has conceptual as well as empirical problems. Therefore we take an event study approach using high-frequency (daily) data to investigate the impact of three categories of news events on eurozone bond yields. Our results indicate that yields react to news on key economic indicators such as growth and budget deficit forecasts. By contrast, we do not find evidence that investors react to announcements of fiscal bailouts or austerity measures.