What uncertainty does to euro area sovereign bond markets: Flight to safety and flight to quality. (April 2022)

• Record Type: Journal Article
• Authors: Costantini, Mauro; Sousa, Ricardo M.
• Is Part Of: Journal of international money and finance. Volume 122(2022)
• Publication Date: 2022-04
• Subjects: Sovereign bonds -- Uncertainty -- Flight to safety -- Flight to quality -- Euro area -- Panel data; C33 -- E21 -- E44 -- D12; International finance -- Periodicals; Foreign exchange -- Periodicals; Finances internationales -- Périodiques; Change -- Périodiques; Foreign exchange; International finance; Periodicals; 332.04205
• DOI: 10.1016/j.jimonfin.2021.102574
• Languages: English
• ISSNs: 0261-5606

Abstract

Highlights: We use a panel of 10 euro area countries over the period 1996Q1-2017Q4. More (policy) uncertainty leads to flights to: (i) "safety"; and (ii) "quality". Global/macroeconomic/common outperform country/financial/idiosyncratic uncertainty. Business and economic uncertainty is key versus politics and government uncertainty. Results hold to yield inversions, risk metrics, monetary conditions and debt crises. Abstract: We use a panel of 10 euro area countries over the period 1996Q1-2017Q4 to show that heightened uncertainty leads to ( i ) a flight to "safety" and ( ii ) a flight to "quality" in sovereign bond markets. Global, macroeconomic and the common euro area uncertainty outperform country-level, financial and euro area idiosyncratic uncertainty in forecasting sovereign bond risk premia, respectively. A rise in economic policy uncertainty also pushes investors to demand a disproportionately larger premium to hold "risky" bonds versus the "safe-haven" bond. Finally, business and economic related uncertainty is of first-order importance, while politics and government uncertainty plays a somewhat secondary role. Our results are robust to yield curve inversions, risk rating metrics, (non-standard) monetary policy conditions and the occurrence of sovereign debt crises.