The impact of crisis periods and monetary decisions of the Fed and the ECB on the sovereign yield curve network

Abstract

This study investigates the sovereign yield curve network of 12 developed countries. We decompose the term structure of interest rates into the Level, Slope, and Curvature factors using the Diebold and Li (2006) model. The connections between the latent yield curve factors across the countries are measured using the Toda and Yamamoto (1995) model, which is suitable for cointegrated time series. Our timeframe covers more than 23 years; therefore, we are able to compare two global and two local crisis periods. For deeper understanding the structural changes, and identify the key participants in the sovereign yield curve network, we analyze the connections on factor, country, and node levels. Investigating the network on node level, in the entire sample period, all three US latent factors act as key participants in our network, however, their contribution is time variant. We find that local and global crises behave differently. The network density differences on average are relatively small across calm and local crises periods, but significantly larger during the Global Financial Crisis and the European sovereign debt crises. Furthermore, we explore links between the easing and tightening decisions by the Fed and the ECB, and the time-varying dominance of the US yield curve in our sovereign yield curve network. The dominance of the US factors peaks if the Fed leads the hiking cycle and reaches its minimum when the interest rate cycle is led by the ECB.