The term structure of interest rates in a heterogeneous monetary union

James Costain, Galo Nuño Barrau and Carlos Thomas

No 1165, BIS Working Papers from Bank for International Settlements

Abstract: We build an arbitrage-based model of the yield curves in a heterogeneous monetary union with sovereign default risk, which can account for the asymmetric shifts in euro area yields during the Covid-19 pandemic. We derive an affine term structure solution, and decompose yields into term premium and credit risk components. In an extension, we endogenize the peripheral default probability, showing that it decreases with central bank bond-holdings. Calibrating the model to Germany and Italy, we show that a "default risk extraction" channel is the main driver of Italian yields, and that flexibility makes asset purchases more effective.

Keywords: sovereign default; quantitative easing; yield curve; affine model; Covid-19 crisis; ECB; pandemic emergency purchase programme (search for similar items in EconPapers)
JEL-codes: E5 F45 G12 (search for similar items in EconPapers)
Date: 2024-02
New Economics Papers: this item is included in nep-ban, nep-cba, nep-eec, nep-mac, nep-mon and nep-opm
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Related works:
Working Paper: The Term Structure of Interest Rates in a Heterogeneous Monetary Union (2024)
Working Paper: The Term Structure of Interest Rates in a Heterogeneous Monetary Union (2022)
Working Paper: The Term Structure of Interest Rates in a Heterogeneous Monetary Union (2022)
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Persistent link: https://EconPapers.repec.org/RePEc:bis:biswps:1165

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