Time-varying Integration in European Government Bond Markets

Abstract Bond market integration clearly changes in response to economic and financial conditions, since the level of risk aversion changes and investors require time-varying compensation for accepting a risky payoff from financial assets. In this paper we examine the dynamic behaviour of European Government bond market integration using an asset pricing model based on that of Bekaert and Harvey (). Our sample period begins in 2004, after a period of calm and tranquillity, and ends in 2009, with a significant widening of sovereign bond spreads. Our results show evidence of time-varying level of integration for all European countries and suggest that, from the beginning of the financial market tensions in August 2007, markets moved towards higher segmentation, and the differentiation of country risk factors increased substantially across countries. However, the impact of the financial and economic crisis has been much more harmful for EMU members' sovereign bond markets, since it has prompted an important backward step in their integration process.