Drivers of Euro Area Yield Spreads: Economic Fundamentals or Psychology? - A study of long term government bond yield spreads from 1990 to 2014
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We analyze government bond yield spreads in Greece, Ireland, Portugal, Spain, and Italy from 1990 to 2014. Seeking to identify the effects of economic fundamentals and psychology, we split the time period into four regimes of relatively consistent risk perception. We fit moving average models for each regime, thus allowing relationships between explanatory variables to fundamentally differ across countries and time periods. To distinguish between common movements and country-specific deviations we also fit mixed effects panel data models. We combine the regressions with a spillover analysis to understand how the Greek government bond market affects the others, both with respect to interdependence and contagion. Our findings suggest that fundamentals drive the spreads in the long run, while psychology outweighs these factors in shorter time periods in response to economic events.