European Government Bond Dynamics and Stability …...European Government Bond Dynamics and...
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European Government Bond Dynamics and Stability Policies: Taming Contagion Risks Martin Hillebrand European Stability Mechanism Peter Schwendner Martin Schüle Thomas Ott Zurich University of Applied Sciences
Transcript of European Government Bond Dynamics and Stability …...European Government Bond Dynamics and...
European Government Bond Dynamics and Stability Policies:
Taming Contagion Risks
Martin Hillebrand
European Stability Mechanism
Peter Schwendner
Martin Schüle
Thomas Ott
Zurich University of Applied Sciences
Introduction
EFSF and ESM have been established on the capital market since 2011.
They have become important players on the Euro area bond market with outstanding volume
of a small euro area country.
Hence, the euro area sovereign bond market as a whole needs attention:
• From a Euro area governance perspective:
» How homogeneous/diverse is the market? Are there clusters, blocks?
» In the context of the euro crisis, does the market fear contagion risks?
• From an EFSF/ESM funding perspective:
» What is the market risk of EFSF bonds in comparison to Euro area countries?
» Is the EFSF bond yield rather driven by asset quality or guarantee structure?
• From an investor perspective:
» Which structures/patterns are stable enough to be used for a risk-reducing hedging strategy?
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Case Study: Euro area crisis
Generic 10yr bonds
12 issuers: EFSF and 11 euro area sovereigns
2
Greek 2015
elections
announced
1990 1995 2000 2005 2010 20150
5
10
15
20
25
30
35
40
EFSF
DE
FI
NL
AT
FR
BE
IE
ES
IT
PT
GR
Year
10
Y B
on
d Y
ield
s in %
Convergence before
EUR introduction
Financial crisis becomes
Euro area debt crisis.
Yield volatilities spike up,
yield levels diverge.
ECB measures and
EFSF/ESM setup
daily bond returns ~ ( - Duration) × [yield(t)-yield(t-1)]
+ yield(t-1) × dt
Bond Carry
Duration Risk
Issuer Current 10Yr Yields Yields Vol since 6/2011
EFSF 0.71 0.68
DE 0.19 0.76
FI 0.47 0.73
NL 0.41 0.73
AT 0.39 0.76
FR 0.53 0.76
BE 0.57 0.89
IE 0.87 1.55
ES 1.61 1.56
IT 1.50 1.5
PT 3.09 2.92
EL 7.32 11.45
Annual correlations of daily bond yield changes 2004 - 2009
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Annual correlations of daily bond yield changes 2010-2015
4
Yield return correlations
We aim to discuss yield dynamics as close to the market as possible
Therefore, we use a model free approach, based on correlations
The Pearson Correlation coefficient is defined as:
• Where Xi and Yi denote the yield return time series of two bonds with n returns
Problem with correlations:
• They are unstable
• Hidden factors lead to spurious correlations
5
high
motivation
marks at
school
real life
success
?
Method overview: from time series to networks
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EF
SF
DE FI
NL
AT
FR
BE IE ES IT PT
GR
01-Jan-2010 -31-Dec-2010
EFSFDE FI
NL AT FR BE IE
ES IT
PT GR
EF
SF
DE FI
NL
AT
FR
BE IE ES IT PT
GR
03-Jan-2011 -30-Dec-2011
EFSFDE FI
NL AT FR BE IE
ES IT
PT GR
EF
SF
DE FI
NL
AT
FR
BE IE ES IT PT
GR
02-Jan-2012 -31-Dec-2012
EFSFDE FI
NL AT FR BE IE
ES IT
PT GR
EF
SF
DE FI
NL
AT
FR
BE IE ES IT PT
GR
01-Jan-2013 -31-Dec-2013
EFSFDE FI
NL AT FR BE IE
ES IT
PT GR
EF
SF
DE FI
NL
AT
FR
BE IE ES IT PT
GR
01-Jan-2014 -31-Dec-2014
EFSFDE FI
NL AT FR BE IE
ES IT
PT GR
EF
SF
DE FI
NL
AT
FR
BE IE ES IT PT
GR
01-Jan-2015 -28-Aug-2015
EFSFDE FI
NL AT FR BE IE
ES IT
PT GR
Bond yield time series
Correlation matrix
Bootstrap filter Filtered influence network
1990 1995 2000 2005 2010 20150
5
10
15
20
25
30
35
40
EFSF
DE
FI
NL
AT
FR
BE
IE
ES
IT
PT
GR
-0.5 -0.4 -0.3 -0.2 -0.1 0 0.1 0.20
200
400
600
800
1000
1200
1400
1600
Correlation influence
EF
SF
DE FI
NL
AT
FR
BE IE ES IT PT
GR
03-Jan-2011 -30-Dec-2011
EFSFDE FI
NL AT FR BE IE
ES IT
PT GR
EF
SF
DE FI
NL
AT
FR
BE IE ES IT PT
GR
02-Jan-2012 -31-Dec-2012
EFSFDE FI
NL AT FR BE IE
ES IT
PT GR
EF
SF
DE FI
NL
AT
FR
BE IE ES IT PT
GR
01-Jan-2013 -31-Dec-2013
EFSFDE FI
NL AT FR BE IE
ES IT
PT GR
EF
SF
DE FI
NL
AT
FR
BE IE ES IT PT
GR
01-Jan-2014 -31-Dec-2014
EFSFDE FI
NL AT FR BE IE
ES IT
PT GR
EF
SF
DE FI
NL
AT
FR
BE IE ES IT PT
GR
01-Jan-2015 -28-Aug-2015
EFSFDE FI
NL AT FR BE IE
ES IT
PT GR
Partial correlation influence
The partial correlation measure is defined as
The correlation influence is defined as
The average correlation influence is defined as
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Small absolute value would mean „Z
strongly affects correlations between X and
Y“
„How much of the correlation between X
and Y is explained by their correlations to
Z?“
„How much does Z explain correlations
between X and all other markets?“
Constructing Filtered Partial Correlation Networks
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The noise in the correlation influence estimator depends heavily on the specific pair:
DE->FR is very stable, but DE->GR is very volatile. We need a filtering concept.
We bootstrap average influences
• We draw n times a sample (with replacement) from the data, using data blocks of length 1-10 days
• For each sample, we calc the average influence matrix and the stddev across the samples
• These standard deviations act as „blur“ indicator of the average influences
abs(mean) > 3 * stddev => correlation influence is «significant»
-0.5 -0.4 -0.3 -0.2 -0.1 0 0.1 0.20
200
400
600
800
1000
1200
1400
1600
Histogram of corr influence bootstrap
Finland -> Greece in 2015
stddev of the bootstrap samples
Correlation influence
frequ
ency
Partial correlation networks of daily bond yield changes 2004 - 2009
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2004. 2005 2006
2007 2008 2009
Blue arrows:
dominating positive
correlations =>
reinforcing movements
Red arrows: dominating
negative correlations =>
diverging movements
Partial correlation networks of daily bond yield changes 2010 - 2015
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Blue arrows:
dominating positive
correlations =>
reinforcing movements
Red arrows: dominating
negative correlations =>
diverging movements
2010. 2011 2012
2013 2014 2015
Case Study: Negotiations of third Greek Programme
Question:
Did the market imply contagion risk to other
Euro area countries beyond Greece?
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Q4-14 Q1-15 Q2-15 Q3-150
2
4
6
8
10
12
14
16
18
20
EFSF
DE
FI
NL
AT
FR
BE
IE
ES
IT
PT
GR
Timespan 10/2014 – 9/2015
10
Y B
on
d Y
ield
s i
n %
Reuters, 19 April 2015:
“Greece's Varoufakis warns of
Grexit contagion”
Reuters, 27 June 2015:
“Euro zone prepared to guard
against Greek risks –
Dijsselbloem”
EF
SF
DE FI
NL
AT
FR
BE IE ES IT PT
GR
19-Jan-2015 08:00:00 -23-Jan-2015 17:00:00
EFSF
DE
FI
NL
AT
FR
BE
IE
ES
IT
PT
GR
EF
SF
DE FI
NL
AT
FR
BE IE ES IT PT
GR
26-Jan-2015 07:00:00 -30-Jan-2015 17:00:00
EFSF
DE
FI
NL
AT
FR
BE
IE
ES
IT
PT
GR
EF
SF
DE FI
NL
AT
FR
BE IE ES IT PT
GR
02-Feb-2015 08:00:00 -06-Feb-2015 17:00:00
EFSF
DE
FI
NL
AT
FR
BE
IE
ES
IT
PT
GR
EF
SF
DE FI
NL
AT
FR
BE IE ES IT PT
GR
09-Feb-2015 08:00:00 -13-Feb-2015 17:00:00
EFSF
DE
FI
NL
AT
FR
BE
IE
ES
IT
PT
GR
EF
SF
DE FI
NL
AT
FR
BE IE ES IT PT
GR
16-Feb-2015 07:00:00 -20-Feb-2015 17:00:00
EFSF
DE
FI
NL
AT
FR
BE
IE
ES
IT
PT
GR
EF
SF
DE FI
NL
AT
FR
BE IE ES IT PT
GR
23-Feb-2015 07:00:00 -27-Feb-2015 17:00:00
EFSF
DE
FI
NL
AT
FR
BE
IE
ES
IT
PT
GR
12
EF
SF
DE FI
NL
AT
FR
BE IE ES IT PT
GR
19-Jan-2015 08:00:00 -23-Jan-2015 17:00:00
EFSF
DE
FI
NL
AT
FR
BE
IE
ES
IT
PT
GR
EF
SF
DE FI
NL
AT
FR
BE IE ES IT PT
GR
26-Jan-2015 07:00:00 -30-Jan-2015 17:00:00
EFSF
DE
FI
NL
AT
FR
BE
IE
ES
IT
PT
GR
EF
SF
DE FI
NL
AT
FR
BE IE ES IT PT
GR
02-Feb-2015 08:00:00 -06-Feb-2015 17:00:00
EFSF
DE
FI
NL
AT
FR
BE
IE
ES
IT
PT
GR
EF
SF
DE FI
NL
AT
FR
BE IE ES IT PT
GR
09-Feb-2015 08:00:00 -13-Feb-2015 17:00:00
EFSF
DE
FI
NL
AT
FR
BE
IE
ES
IT
PT
GR
EF
SF
DE FI
NL
AT
FR
BE IE ES IT PT
GR
16-Feb-2015 07:00:00 -20-Feb-2015 17:00:00
EFSF
DE
FI
NL
AT
FR
BE
IE
ES
IT
PT
GR
EF
SF
DE FI
NL
AT
FR
BE IE ES IT PT
GR
23-Feb-2015 07:00:00 -27-Feb-2015 17:00:00
EFSF
DE
FI
NL
AT
FR
BE
IE
ES
IT
PT
GR -0.6
-0.4
-0.2
0
0.2
0.4
0.6
0.8
1
Correlations in
weekly intervals,
using hourly yields
Weekly correlations of hourly bond yield changes Jan – Feb 2015
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After Syriza won Before Greek elections
19.1.-23.1. 26.1.-30.1. 2.2.-6.2.
9.2.-13.2. 16.2.-20.2. 23.2.-27.2.
Tsipras’ tour across Europe
Nervousness before Eurogroup
Brussels Tsipras confirms election
promises
Blue arrows: dominating
positive correlations =>
reinforcing movements
Red arrows: dominating
negative correlations =>
diverging movements
Greece commits to programme extension;
«Troika» become «Institutions»
Partial correlation networks of daily bond yield changes Jan – Feb 2015
EF
SF
DE FI
NL
AT
FR
BE IE ES IT PT
GR
08-Jun-2015 08:00:00 -12-Jun-2015 17:00:00
EFSF
DE
FI
NL
AT
FR
BE
IE
ES
IT
PT
GR
EF
SF
DE FI
NL
AT
FR
BE IE ES IT PT
GR
15-Jun-2015 07:00:00 -19-Jun-2015 17:00:00
EFSF
DE
FI
NL
AT
FR
BE
IE
ES
IT
PT
GR
EF
SF
DE FI
NL
AT
FR
BE IE ES IT PT
GR
22-Jun-2015 08:00:00 -26-Jun-2015 17:00:00
EFSF
DE
FI
NL
AT
FR
BE
IE
ES
IT
PT
GR
EF
SF
DE FI
NL
AT
FR
BE IE ES IT PT
GR
29-Jun-2015 08:00:00 -03-Jul-2015 17:00:00
EFSF
DE
FI
NL
AT
FR
BE
IE
ES
IT
PT
GR
EF
SF
DE FI
NL
AT
FR
BE IE ES IT PT
GR
06-Jul-2015 08:00:00 -10-Jul-2015 17:00:00
EFSF
DE
FI
NL
AT
FR
BE
IE
ES
IT
PT
GR
EF
SF
DE FI
NL
AT
FR
BE IE ES IT PT
GR
13-Jul-2015 07:00:00 -17-Jul-2015 17:00:00
EFSF
DE
FI
NL
AT
FR
BE
IE
ES
IT
PT
GR
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Correlations in
weekly intervals,
using hourly yields
EF
SF
DE FI
NL
AT
FR
BE IE ES IT PT
GR
19-Jan-2015 08:00:00 -23-Jan-2015 17:00:00
EFSF
DE
FI
NL
AT
FR
BE
IE
ES
IT
PT
GR
EF
SF
DE FI
NL
AT
FR
BE IE ES IT PT
GR
26-Jan-2015 07:00:00 -30-Jan-2015 17:00:00
EFSF
DE
FI
NL
AT
FR
BE
IE
ES
IT
PT
GR
EF
SF
DE FI
NL
AT
FR
BE IE ES IT PT
GR
02-Feb-2015 08:00:00 -06-Feb-2015 17:00:00
EFSF
DE
FI
NL
AT
FR
BE
IE
ES
IT
PT
GR
EF
SF
DE FI
NL
AT
FR
BE IE ES IT PT
GR
09-Feb-2015 08:00:00 -13-Feb-2015 17:00:00
EFSF
DE
FI
NL
AT
FR
BE
IE
ES
IT
PT
GR
EF
SF
DE FI
NL
AT
FR
BE IE ES IT PT
GR
16-Feb-2015 07:00:00 -20-Feb-2015 17:00:00
EFSF
DE
FI
NL
AT
FR
BE
IE
ES
IT
PT
GR
EF
SF
DE FI
NL
AT
FR
BE IE ES IT PT
GR
23-Feb-2015 07:00:00 -27-Feb-2015 17:00:00
EFSF
DE
FI
NL
AT
FR
BE
IE
ES
IT
PT
GR -0.6
-0.4
-0.2
0
0.2
0.4
0.6
0.8
1
Weekly correlations of hourly bond yield changes Jun - Jul 2015
15
Ongoing negotiations Blue arrows: dominating
positive correlations =>
reinforcing movements
Red arrows: dominating
negative correlations =>
diverging movements
Tsipras meets Putin
8.6.-12.6. 15.6.-19.6. 22.6.-26.6.
29.6.-3.7. 6.7.-10.7. 13.7.-17.7.
Greece commits to third programme
Many Eurogroup
meetings without results
Referendum announced.
ECB does not raise ELA.
Capital controls.
Referendum against
programme,
ECB still does not raise ELA
limit
Partial correlation networks of daily bond yield changes Jun - Jul 2015
Ongoing negotiations
Outlook: use partial correlation networks for dynamic hedging
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Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16-4
-2
0
2
4
6
8
10
Perf
orm
ance A
ppro
xim
ation in %
PnL Static Equal-Weight Portfolio
PnL Dynamic Hedge• Dynamically hedging Euro
area bonds that were exposed
to negative correlation
influences in the previous
week.
• Reduces portfolio volatility
compared to an equally
weighted portfolio.
daily bond returns ~ ( - Duration) × [yield(t)-yield(t-1)]
+ yield(t-1) × dt
Bond Carry
Duration Risk
Conclusions and Outlook
In periods of financial and political distress, the market feared contagion risks, shearing
forces between a core and a periphery bloc.
Market trusts the guarantee structure of EFSF: market treats EFSF as a „core“ issuer.
Market believes in stability framework: reattachment of periphery to core, Greece a special
case.
Our network approach extracts significantly strong and stable partial correlations which can
be used for a risk-reducing hedge strategy for an investment portfolio.
Further steps:
Hedging strategy can be refined.
Secondary market flows can be included in the analysis.
Macroeconomic covariates could be incorporated.
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