Government bond yield spreads in EMU countries: The story of an ephemeral convergence

A Work Project, presented as part of the requirements for the Award of a Masters Degree in Economics from the NOVA – School of Business and Economics

The inception of the European Monetary Union appeared to have accomplished the yields’ convergence goal of Maastricht. Suddenly however, spreads against Germany started escalating towards the values of the early nineties. Through the usage of a fixed-effects Arellano-Bond dynamic panel estimation, this thesis tries to discern the role of liquidity and fiscal fundamentals in determining yield differentials for ten EMU countries. While markets tend to monitor high debtors via more structural fiscal measures, a late and abrupt reaction, as risk perceptions increased, unveiled the unannounced fiscal unsoundness of the peripheral. The consequent defaults will put into question the credibility of the Stability and Growth Pact. In this context, unobserved individual effects seem to be the least of our concerns.