The effect of government bond supply on term structure and corporate debt maturity: Evidence from euro area

Abstract

Purpose of the Study This thesis studies the effect of German government bond maturity structure on both the yield curve and excess returns (return of long maturity bond in excess of short term yield) in the euro denominated sovereign bond markets. In addition, I study whether corporations with euro denominated bonds react to changes in the maturity structure of government debt by altering their respective maturity structure of debt.

Data and Methodology The data set includes all public euro denominated debt issued by either a member country of the European Monetary Union or a corporation. I have collected every such bond traded between the inception of EMU (January 1999), and the present (May 2010). This amounts to a total of 798 government bonds and 5217 corporate bonds. I conducted several Ordinary least squares (OLS) regressions with varying set-ups. The regressions have been conducted by using a Newey-West approach allowing for the high autocorrelation found in the time series.

Results I find the maturity structure of German sovereign debt to influence the term structure, the effect being larger for longer maturities. Since the inception of the credit crunch this causality has however ceased to exist and to some extent even reversed. The results also show that both lengthening of the maturity structure and losses incurred by arbitrageurs in carry trades lead to successive increased excess returns, the results being stronger for longer maturities. Finally, I find that corporations react to changes in government maturity structure, especially when government debt share is large.