Foreign Investor Flows and Sovereign Bond Yields in Advanced Economies

Abstract

A sset allocation decisions of international investors are at the core of capital flows. This paper explores the impact of th ese decisions on long - term government bond yields , u sing a quarterly investor base dataset for 22 advanced economies over 2004 ‒ 2012. We find that a one percentage point increase in the share of government debt held by foreign investors can explain a 6 ‒ 10 b asis point reduction in long - term sovereign bond yields over the sample period . Accordingly, i nternational flows to core advanced econom y bond markets over 2008 ‒ 12 are estimated to have reduced 10 - year government bond yields by 40 ‒ 65 basis points in Germany , 20 ‒ 30 basis points in the U.K., and 35 ‒ 60 basis points in the U.S. In contrast, foreign outflows are estimated to have raised 10 - year government bond yields by 40 ‒ 70 basis points in Italy and 110 ‒ 180 basis points in Spain during the same period . O ur results suggest that the divergence in long - term bond yields between core and periphery economies in the euro area may continue unless the “normalization” of macroeconomic determinants of bond yields is accompanied by a similar “normalization” of the fo reign investor base