High- and low-frequency correlations in European government bond spreads and their macroeconomic drivers

We propose to adopt high-frequency DCC-MIDAS models to estimate high- and low-frequency correlations in the 10-year government bond spreads for Belgium, France, Italy, the Netherlands, and Spain relative to Germany, from June 1, 2007 to May 31, 2012. The high-frequency component, reflecting financial market conditions, is evaluated at 15-minute frequency, while the low-frequency component, fixed through a month, depends on country-specific macroeconomic conditions. We find strong links between spreads volatility and worsening macroeconomic fundamentals; in presence of similar macroeconomic fundamentals relative spreads move together; the increasing correlation in spreads during the burst of the sovereign debt crisis cannot be entirely ascribed to macroeconomic factors but rather to changes in market liquidity.