Redenomination risk connectedness among European sovereign bond markets

Abstract

Purpose This paper aims to investigate the interconnectedness of redenomination risk premiums across the four main European sovereign bond markets (France, Germany, Italy and the Netherlands). Design/methodology/approach The authors used the time-varying parameter vector autoregressions method to achieve the objectives. Findings This study reveals that the redenomination risk connectedness throughout the Euro area sovereign bond markets is dynamic and exhibits remarkable variations across various crisis episodes, such as the COVID-19 pandemic and Russia–Ukraine tensions. In addition, the analysis uncovers significant bilateral connections between countries. Furthermore, the research finds that spillovers from the US dollar redenomination premium (USDRP) are greater than those from the euro redenomination premium (ERP) and currency redenomination premium (CRP). However, during the Ukraine–Russia tensions, the connectedness between the USDRP is stronger than that between the ERP and CRP. On the other hand, the connectedness between CRP is higher than the USDRP and ERP during the COVID-19 pandemic. Importantly, this study demonstrates that the four countries play a role as both shock transmitters and receivers, switching alternatively. Originality/value This study contributes to the related literature by exploring the redenomination risk connectedness throughout the Euro area sovereign bond markets. Specifically, we rely on the USDRP, the ERP and CRP. These findings have serious implications for both portfolio risk management.