Euro Area: Towards a European Common Bond? – Empirical Evidence from the Sovereign Debt Markets

• Published date: 01 July 2022
• Author: Nikolaos Stoupos,Apostolos Kiohos
• Date: 01 July 2022
• DOI: http://doi.org/10.1111/jcms.13297

Euro Area: Towards a European Common Bond? –Empirical

Evidence from the Sovereign Debt Markets

NIKOLAOS STOUPOSand APOSTOLOS KIOHOS

Department of International and European Studies, University of Macedonia, Thessaloniki

Abstract

Despite the debt crisis of the period 2010–15, the Eurozone did not manage to adopt an eff‌icient

policy for reinforcing the creation of a common bond among the members-states of the union. Un-

der these circumstances, the research aim of this manuscript is to further explore the integration

level of bond markets in the EMU after the end of the 2010 debt crisis and the potential creation

of a Euro Area common bond. The empirical evidence we gathered is suggestive of a signif‌icant

integration degree of bond markets in the Euro Area, whereas plenty of asymmetries exist among

the member-states notwithstanding. The dominant role of France, the Netherlands, Germany, Italy,

Ireland and Spain on the EA bond markets were unveiled. As a matter of fact, we propose that the

EMU be conditionally prepared to issue a common Eurozone bond which will safeguard the f‌inan-

cial stability in the monetary union.

Keywords: bond markets risk; FCVAR; realized EGARCH; EMU unif‌ication; f‌inancial integration

Introduction

Since the beginning of the creation of the Euro Area (EA) in 1999, the European f‌inancial

markets have experienced three different and contrasting events; the circulation of euro in

2002, the 2008 global f‌inancial crisis and the 2010 sovereign debt crisis in EA periphery

countries. The introduction of the euro facilitated the acceleration of the f‌inancial integra-

tion in the monetary union through a variety of channels. The common currency repealed

the exchange rate barriers and therefore offered direct access to investors in the EA bond

markets from different countries. The presence of a common central bank (ECB) assisted

the member-countries to reap the benef‌its of low inf‌lation and stable interest rates. Hence,

investors faced higher similarity regarding the discounted rates of their future cash f‌lows.

Moreover, the markets evaluated that the default risk had been similar among the EA

member-states despite continuous f‌iscal mismanagement and current accounts def‌icit. This

incident subserved the most vulnerable EA economies by far to enjoy low borrowing cost

and grant access to more funding sources. Nevertheless, plenty of researchers (Chari

et al., 2020; Hafner and Jager, 2013) have discussed that this ‘illusion’of the f‌inancial mar-

kets was the cause of the 2010 sovereign debt crisis since the EMU does not meet the shar-

ing system criterion of the optimal currency area (McKinnon, 1963; Mundell, 1961).

A risk sharing system could have been an automatic f‌iscal transfer mechanism to redis-

tribute money to areas/sectors. This takes the form of a taxation redistribution to the less

developed areas of a country/region. The EU Stability and Growth Pact does not allow

f‌iscal transfers among the member-states. The only sustainable risk sharing system could

have been the issue of a Eurobond where the EA member-states would issue common

debt (Beetsma and Mavromatis, 2014) and enjoy uniform default risk.

JCMS 2022 Volume 60. Number 4.pp. 1019–1046DOI: 10.1111/jcms.13297

© 2021 University Association for Contemporary European Studies and John Wiley & Sons Ltd

The idea of Eurozone common bonds was initially proposed during the emergence of

the sovereign debt crisis in 2010. The issuance of a single intergovernmental bond by the

European monetary union (EMU) reached an ardent conf‌lict point of lengthy debates at

that period. In 2020, the spread of COVID-19 pandemic forced every EA member-state

to put their economies on lockdown which provoked an asymmetric economic shock

across the monetary union (Celi et al., 2020). Countries that suffered the most due to

the pandemic (France, Spain, and Italy) re-proposed the issue of Eurobonds as a recovery

solution. However, the resistance of the Netherlands, Finland and Germany was intense

due to the problem of moral hazard and debt mutualization (Esteves and Tunçer, 2016).

Nowadays, each member-state persists to issue its own government bonds and enjoy

different borrowing costs. Essentially, international f‌inancial markets lend to each EA

member-state with differentiated interest rates by considering their creditability, the ratio

of public debt to GDP, the economic growth, and other macroeconomic or political fac-

tors. The role of emergency funding has been primarily placed on the European Stability

Mechanism (ESM) and auxiliary of the European Commission. The task of regular

funding has been assigned to the Central governments of each member state by issuing

government bonds and Treasury bills.

In the light of all this political and economic background, it becomes understood that a

research lacuna exists which concerns the evolution of the f‌inancial integration of the

monetary union and more particularly, the bond markets. So far (2021), the Eurozone

has been integrated only with regard to monetary, economic (common currency and cen-

tral bank) and banking terms (European Banking Union). On the other hand, a decelerated

integrated level occurred in the EA f‌inancial markets during the 2010 sovereign debt cri-

sis (Abad et al., 2014).

Christiansen (2014), Deltuvaite (2015), Pozzi and Wolswijk (2012) have endorsed on

the imperfect integration of EA bond markets before and during the 2010 sovereign debt

crisis. This research was motivated from these studies in order to explore further the de-

gree of bond markets integration in the Eurozone after the end of the sovereign debt crisis

in July 2015 (Baldwin and Giavazzi, 2015). Specif‌ically, this paper examines the level of

Eurozone bond markets synchronization in three distinct countries clusters (core, periph-

ery and east). Lastly, it presents signif‌icant f‌indings concerning the consideration and the

establishment of a Eurozone common state bond.

To answer this research query, weare based on the theory of f‌inancial integration

and on its direct type. Baele et al. (2004) classif‌ied the f‌inancial integration among

the categories of total, direct and indirect. Direct f‌inancial integration, which is also

called as f‌inancial markets integration, is expressed in deviations from the law of

one price for f‌inancial securities (Codogno et al., 2003). Under perfect direct f‌inancial

integration, an investor can expect the same return on investments with similar lending

costs from different markets considering risk adjustment. If the differential in expected

risk-adjusted returns is greater than zero but less than or the same as the transaction

cost, we mention that markets are disintegrated but are nonetheless eff‌icient (Stavarek

et al., 2011). Liebscher et al. (2006) show that direct f‌inancial integration can take

many forms and present various aspects, such as that of monetary unions. The sup-

porters of f‌inancial markets integration indicate that this type of integration could offer

more opportunities for risk sharing and risk diversif‌ication, better allocation of capital

among investment opportunities and potential for higher economic development

Nikolaos Stoupos and Apostolos Kiohos1020

© 2021 University Association for Contemporary European Studies and John Wiley & Sons Ltd