piraeus bank group


Understanding Greek Government Bond Spreads a different perspective

Since the outbreak of the Great Financial Crisis in 2008 and especially after the escalation of the Greek Crisis in 2010, both academics and investment analysts have devoted a lot of effort in exploring the behavior of Greek as well as other periphery economies bond rates vs their corresponding German yields. In what follows we revisit the issue of the behavior, pricing and risk management of Greek Government Bonds (GGBs) spreads and try to address a number of unresolved issues.

The additional contribution we make to the already available body of research is twofold: 

  1. First, we estimate our models using the quantile regression (QR) methodology instead of the usual OLS method. QR offers a number of advantages vs more traditional methods, the most important of which is that it allows different factors with varying degree of sensitivity on the likely outcomes of Greek Bond spreads. This is of particular significance in the Greek case as spreads vary from a low of 9 bps to a high of 3313 bps.

  2. Second, in defining the explanatory variables we follow what we call the “FX Analogy”, which simply means that all explanatory variables enter our model as “spreads” or “ratios” to their corresponding German ones.

The aim of our research is to enhance our understanding on the fundamental behavior of the Greek Government Bond Spreads both before and after the Greek economic crisis. We do that by trying to address those aspects that relate with the fundamental driving factors, the underlying risks, the implied “fair” value and our model’s flexibility in explaining Greek bond spreads.

According to our analysis, the main drivers of GGB spreads are the gap in economic performance and competitiveness between the Greek and German economies as well as the widening differences in the debt-to-GDP ratios. In addition, contagion from movements in other peripheral bond markets is evident, especially in periods of widespread market stress. Our model also reveals substantial variation on the magnitude and direction (sign) of the influence of the above mentioned factors. Economic Activity and Competitiveness have a significant impact on the likeliness of medium and low levels of conditional spreads while Fiscal Sustainability and especially Periphery Risk are of increased importance on the likely occurrence of high bond spreads.

At the current juncture, Greek Bonds are, by and large, aligned to their fundamentals but our Misalignment Index is able to identify periods of substantial divergences between spreads and their fundamentals while the Balance of Risk Indicator highlights periods of highly skewed risks. Finally, we demonstrate how our methodology can be utilized to produce more accurate value-at-risk estimates as well as forecasts of the distribution of GGB spreads under various economic scenarios.