ECB: sovereign market stress beyond credit spreads

Ott 20 2018

The European Central Bank (ECB) recently issued a working paper which attempts to construct a measure of stress for European sovereign bond markets detaches itself from the use of sovereign bond spreads.

Quantifying stress in sovereign bond markets is a relevant task since such tensions can easily spill over to other important financial market segments, raising the odds of a systemic crisis in the financial system as a whole. The so-called sovereign-bank nexus is a case in point for one possible transmission mechanism via which sovereign market stress may become systemic. In the literature sovereign stress is usually measured in terms of either the yield spread of a particular government bond against a “safe” benchmark bond, or by the spread of a credit default swap written on government debt. Both indicators are usually interpreted as a measure of the (excess) default risk premium embedded in the price of a more risky government bond.

A composite indicator of sovereign market stress which is based on a wider set of stress symptoms that includes, apart from yield spreads, a measure of yield volatility and bid-ask spreads. Country information from both the short and the long end of the yield curve is also included. All these different measures of sovereign stress are aggregated into a composite indicator based on the methodology of the ECB’s Composite Indicator of Systemic Stress, CISS. In order to recognise this affinity, we call our indicator the Composite Indicator of Systemic Sovereign Stress, or just SovCISS.

Accordingly, the SovCISS results as a correlation-weighted average of its components which are homogenised in a particular way before the aggregation step. The basic idea is that the overall level of sovereign stress increases (decreases) with a stronger (weaker) correlation between the different measures of stress symptoms. The SovCISS both for euro area member states individually and for the euro area as a whole. The latter provides a yardstick for quickly gauging the extent to which sovereign stress is a more local or a more widespread phenomenon within the euro area.

Beyond spreads: measuring sovereign market stress in the euro area (PDF)


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