Template-Type: ReDIF-Paper 1.0
Author-Name: James Costain
Author-X-Name-First: James
Author-X-Name-Last: Costain
Author-Name: Galo Nuño Barrau
Author-X-Name-First: Galo
Author-X-Name-Last: Nuño Barrau
Author-Name: Carlos Thomas
Author-X-Name-First: Carlos
Author-X-Name-Last: Thomas
Title: The term structure of interest rates in a heterogeneous monetary union
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.
Creation-Date: 2024-02
File-URL: https://www.bis.org/publ/work1165.pdf
File-Format: Application/pdf
File-Function: Full PDF document
File-URL: https://www.bis.org/publ/work1165.htm
File-Format: text/html
Number: 1165
Keywords: sovereign default, quantitative easing, yield curve, affine model, Covid-19 crisis, ECB, pandemic emergency purchase programme
Classification-JEL: E5, G12, F45
Handle: RePEc:bis:biswps:1165