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Euro-zone sovereign bonds and option implied discount rates

Stancu, A. T. (2017) Euro-zone sovereign bonds and option implied discount rates. PhD thesis, University of Reading

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The main focus of this thesis is to investigate interest rates in the Euro-zone and U.S. sovereign bond markets. Chapter 1 provides a general introduction and presents the literature review. Using a rich dataset of high frequency historical information, in Chapter 2 we study the determinants of European sovereign bond returns over calm and crisis periods. We find that the importance of the equity risk factor varies greatly over time and crucially depends on country risk. In low risk countries, government bond returns are negatively related to equity returns, regardless of market conditions. Investors appear to migrate from low risk government bonds to stocks in calm periods and in the opposite direction when markets are under stress. On the other hand, government bonds of high risk countries lose their" safe-asset" status and exhibit more equity¬like behaviour during the sovereign debt crisis, with positive and strongly significant co-movements relative to the stock market. Interestingly, this decoupling in the government bond market results in higher diversification benefits for fixed income investors and pension funds in periods of sovereign stress. In Chapter 3, we study the intra-day effect of international and domestic announcement surprises on Euro-zone sovereign bond yields over calm and crisis periods. Using more than 200 macroeconomic series from 2003 to 2013, we find that bond yields strongly react to US macroeconomic shocks and also to a few UK, German, French and Euro-aggregate macroeconomic shocks. However, this effect has changed as a result of the European sovereign debt crisis, with sovereign bond yields of high risk countries experiencing a deaf response to macroeconomic announcement surprises. Several other characteristics are explored regarding the macro announcement effect on bond yields. We find most announcement shocks to be fully incorporated in bond yields within 5 minutes after the release. Decomposing nominal yields into real yields and inflation premium, we find that Euro-zone sovereign bonds react to macroeconomic shocks mainly through the real yield channel. Finally, exploring the effect of similar macroeconomic announcements which are released at the same time and on the same day, we document that sovereign bond investors pay a closer attention to shocks on the month-over-month or quarter-over-quarter percentage change of core macroeconomic announcements which are not components of other key macroeconomic indicators. Exploiting no-arbitrage option pricing theory, we develop in Chapter 4 a methodology to recover the term structure of discount rates implied by S&P 500 index option prices. On average, implied discount rates are 36 basis points higher than the corresponding Treasury rates. This spread varies over time and is significantly related to variables that proxy for business cycle, credit and liquidity risks. We investigate the information content of the term structure of discount rates and find that long term implied discount rates are mainly informative about future short term discount rates (rather than the term premium). Finally, Chapter 5 concludes the thesis and presents further research ideas.

Item Type:Thesis (PhD)
Thesis Supervisor:Dufour, A. and Varotto, S.
Thesis/Report Department:Henley Business School
Identification Number/DOI:
Divisions:Henley Business School
ID Code:75155
Date on Title Page:2016

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