Understanding greek government bond spreads

Understanding Greek Government Bond Spreads:

A different perspective

Ilias Lekkos [email protected] Staggel [email protected] Giannakidis [email protected]

Economic Research & Investment StrategyJune 2017

mailto:[email protected]



3

Introduction & Motivation

Methodology: Quantile Regression (QR) Analysis

GGB Spreads QR Model

Greek Bond Market Misalignment Index

Value at Risk & Balance of Risks

GGB Spreads Scenario


4

Since the outbreak of the Great Financial Crisis in 2008 and especially after the escalation of the Greek Crisis in

2010, both academics and investment analysts have devoted a lot of effort in exploring the behavior of Greek as

well as other periphery economies bond rates vs their corresponding German yields. In what follows we revisit

the issue of the behavior, pricing and risk management of Greek Government Bonds (GGBs) spreads and try to

address a number of unresolved issues.

The additional contribution we make to the already available body of research is twofold:

First, we estimate our models using the quantile regression (QR) methodology instead of the usual OLS

method. QR offers a number of advantages vs more traditional methods, the most important of which is

that it allows different factors with varying degree of sensitivity on the likely outcomes of Greek Bond

spreads. This is of particular significance in the Greek case as spreads vary from a low of 9 bps to a high of

3313 bps.

Second, in defining the explanatory variables we follow what we call the “FX Analogy”, which simply means

that all explanatory variables enter our model as “spreads” or “ratios” to their corresponding German ones.

Source: Piraeus Bank Research

Aim of the Study

5

The aim of our research is to enhance our understanding on the fundamental behavior of the Greek

Government Bond Spreads both before and after the Greek economic crisis. We do that by trying to

address the following issues:

Which are the fundamental drivers of GGB spreads?

Is this set of driving factors constant or it varies relative to the situation in the Greek bond

market and the size of the spreads?

Even for factors that are significant across the spreads distribution do they maintain a

constant influence (constant betas) on the spreads or this varies as well?

Are Greek Government Bonds fairly valued given the levels of their fundamentals?

Are the risks around their fair value always symmetric or can we identify periods of positive

(i.e. increased probability for narrower spreads) and negative (i.e. increased probability for

wider spreads) risks?

Can we use the enhanced flexibility of the model for risk management purposes? That is, can

we produce more accurate Value-at-Risk analysis for GGB spreads?

Finally, can we employ our model to explore the behavior of GGB spreads under various

macroeconomic scenarios?


Summary of Key Findings

• According to our analysis, the main drivers of GGB spreads are the gap in economicperformance and competitiveness between the Greek and German economies as well as thewidening differences in the debt-to-GDP ratios. In addition, contagion from movements inother Peripheral bond markets is evident, especially in periods of widespread market stress.

• Our model also reveals substantial variation on the magnitude and direction (sign) of theinfluence of the above mentioned factors. Economic Activity and Competitiveness have asignificant impact in a regime of medium and low levels of conditional spreads while FiscalSustainability and especially Periphery Risk are of increased importance in a regime of highconditional spreads.

• At the current juncture, Greek Bonds are, by and large, aligned to their fundamentals but ourMisalignment Index is able to identify periods of substantial divergences between spreads andtheir fundamentals while the Balance of Risk Indicator highlights periods of highly skewed risks.

• Finally, we demonstrate how our methodology can be utilized to produce more accurate value-at-risk estimates as well as forecasts of the distribution of GGB spreads under variouseconomic scenarios.

6Source: Piraeus Bank Research

7







Methodology IQuantile Regressions (QR): Looking Beyond Average Estimates

8

0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

3.00%

3.50%

4.00%

4.50%

-3.8

4

-3.3

8

-2.9

2

-2.4

6

-2.0

0

-1.5

4

-1.0

8

-0.6

2

-0.1

6

0.3

0

0.7

6

1.2

2

1.6

8

2.1

4

2.6

0

3.0

6

3.5

2

3.9

8

4.4

4

4.9

0

right tail

center

left shoulder

left tail

right shoulder

Q25Q5 Q75 Q95Q50

Conditional Probability Density

Quantile Regression is a statistical methodology that models the distribution of the response variable conditional on observed

underlying factors. Specifically, we relate each specific part of the distribution of responses (using quantile functions) to a

number of explanatory variables. Consequently, we are able to produce estimates or projections for the location, dispersion

and shape of the variable’s distribution.

As in standard regression models, quantile regression enable us to analyze the impact of a number of economic variables on

the response variable, the difference being that their influence is not restricted only on the center of the spread distribution but

also on other parts such as its tails and shoulders.

𝑸𝝉 𝒚𝒕 𝒙𝒕 = 𝒂𝝉 + 𝜷𝝉 ∗ 𝒙𝒕

𝒇𝒐𝒓 𝒆𝒂𝒄𝒉 𝒒𝒖𝒂𝒏𝒕𝒊𝒍𝒆 𝝉 = 𝟓𝒕𝒉 , 𝟏𝟎𝒕𝒉,… , 𝟗𝟓𝒕𝒉


Methodology II: QR Advantages over the OLS framework

9

Even though quantile regression does not differ from standard methods in the fact that they use past

information to capture a relation that is assumed to hold in the future, the method does offer a number of

advantages relative to the more standard least squares regression:

The most important is robustness with respect to extreme outcomes (outliers) observed in the past

that are unlikely to occur in the future at least in a medium term horizon.

Quantile regression may result to a more rational asymmetric estimate for the spread distribution

compared to the standard normal distribution that is assumed by least squares which is restricted by

the fact that under OLS, “adverse” outcomes are equally likely to “good” outcomes.

We are able to categorize underlying factors with respect to their influence on each individual

quantile of the spread distribution. For example, we can specify those factors that are associated

strongly with the dispersion of the distribution and those that drive its center or tails. In that way we

can isolate the information that is relevant to the indented use of the model e.g. risk management or

sensitivity under stress scenarios.

By construction, quantile regression provides a natural ranking of the fitted outcomes for the variable

of interest. For example, the median corresponds to the value for bond spread where there is a 50%

probability to observe a higher or a lower outcome. Similarly, the 25th quartile indicates the value for

bond spread where there is a 25% probability to observe lower and 75% probability to observe

higher values.

QR allows us to construct indices that benefit from improved information extracted from the whole

conditional distribution of bond spreads.


Methodology III: QR Model on GGB Spreads

10

Therefore, by estimating the conditional quantile functions of Greek Bond Spreads we effectively model their

whole distribution as a function of several economic state variables. Consequently, by using the QR method we

are able to determine location shifts, changes in uncertainty or changes in market stress for all possible spread

outcomes.

Quantile regression provides a more complete picture for Greek spreads dynamics than would be offered by a

simple average estimate. For example, if we want to investigate what is the impact of an increase in the debt to

GDP differential on the probability of a large surge in spreads, then standard regression methodologies are of

little use.


Modelling GGB Spreads: “The FX Analogy”

11

Most studies try to analyze sovereign spreads as a function of a number of variables (fiscal, growth, etc) that characterize

the economy under examination.

Here we follow a slightly more nuanced approach following what we call the “FX Analogy”. Following a line of reasoning

similar the one used when modelling FX rates, we view all explanatory variables as relative to the benchmark i.e. all

variables are viewed relative to their German counterparts.

Our final model is based on 4 factors, chosen according to qualitative, statistical fit and model parsimony criteria.

The explanatory variables cover the four main areas of: Economic Activity, Competitiveness, Periphery Risk and Fiscal

Sustainability.

Greek Bond Spreads

Economic Activity Greece Vs Germany

CompetitivenessGreece Vs Germany

EA Periphery RiskEA Periphery Vs Germany

Fiscal SustainabilityGreece Vs Germany


10-Year Bond YieldsGreece vs Germany (%)

Greek 10-Year Spread vs Germany (bps)

GGB Spreads: Historical Evolution

12

-5

0

5

10

15

20

25

30

35

40

Jan

-00

Oct

-00

Jul-

01

Ap

r-0

2

Jan

-03

Oct

-03

Jul-

04

Ap

r-0

5

Jan

-06

Oct

-06

Jul-

07

Ap

r-0

8

Jan

-09

Oct

-09

Jul-

10

Ap

r-1

1

Jan

-12

Oct

-12

Jul-

13

Ap

r-1

4

Jan

-15

Oct

-15

Jul-

16

Ap

r-1

7

Germany 10Y Yield Greece 10Y Yield

0

500

1000

1500

2000

2500

3000

3500

Jan

-00

Oct

-00

Jul-

01

Ap

r-0

2

Jan

-03

Oct

-03

Jul-

04

Ap

r-0

5

Jan

-06

Oct

-06

Jul-

07

Ap

r-0

8

Jan

-09

Oct

-09

Jul-

10

Ap

r-1

1

Jan

-12

Oct

-12

Jul-

13

Ap

r-1

4

Jan

-15

Oct

-15

Jul-

16

Ap

r-1

7

German 10-Year yield has gradually decreased from 5.54% in January 2000 to 0.32% in April 2017.

In contrast Greek 10-Year bond yields surged after 2009 recording remarkably high levels in February 2012, due to PSI.

Afterwards yields declined gradually reaching 5.82% in August 2014. In 2014, Greece returned to the bond markets after a

4-year period, in April with a 5-year bond and in July with a 3-year bond.

However, political risk during 2015 that culminated to the June referendum, drove 10-Year Greek bond yields to levels

higher than 30%. After a period of delays in the first and second review of the 3rd Economic Adjustment Programme, the

Greek economic environment showed signs of an apparent stabilization that led Greek 10-Year bond yield to reach 6.34% in

April 2017.


The 4 factors that drive GGB spreads

13

(1) Our analysis was performed on a wider range of relative variables (such as HICP in constant tax, economic sentiment indicator, the proportion of the

banking sector capitalization relative to the aggregate market capitalization etc).

Based on our econometric model (1), the evolution of GGB Spreads (GGB_SPRDS) depends on:

The Relative Economic Activity Indicator calculated as the difference between the logarithms of Real GDP

volume index (2010 =100) of Greece versus Germany (REL_ECACT).

The Relative Cost Competitiveness Indicator, calculated by comparing the real trade weighted exchange

rates between Greece and Germany and defined as the difference between the logarithms of Real

Effective Exchange Rate of Greece versus Germany (REL_CCOMP)

The EA Periphery Risk Indicator, calculated as the average 10-Year bond spreads for Italy, Spain, Portugal

and Ireland versus German 10-Year bond Yield. (EAPER_RISK)

The Relative Fiscal Sustainability Indicator, calculated as the ratio of Debt to GDP of Greece versus Debt to

GDP of Germany (REL_FSCI)


The data are collected from key databases such as Bloomberg, Oxford Economics, BIS and Eurostat.

Wherever is appropriate, the variables are adjusted for seasonality.

Data are monthly and cover the period January 2000 – April 2017.

In the case that only quarterly data are available (i.e. Real GDP, Debt to GDP), whereas the prerequisite is monthly data,

then temporal disaggregation under a cubic spline is used as an interpolation technique.

Real GDP Volume Index (2010=100)Greece vs Germany

Relative Economic Activity Indicator (REL_ECACT)

1st Factor: Relative Economic Activity Indicator

14

78

83

88

93

98

103

108

113

118

Jan

-00

Oct

-00

Jul-

01

Ap

r-0

2

Jan

-03

Oct

-03

Jul-

04

Ap

r-0

5

Jan

-06

Oct

-06

Jul-

07

Ap

r-0

8

Jan

-09

Oct

-09

Jul-

10

Ap

r-1

1

Jan

-12

Oct

-12

Jul-

13

Ap

r-1

4

Jan

-15

Oct

-15

Jul-

16

Ap

r-1

7

Germany RGDP Index Greece RGDP Index

-0.35

-0.30

-0.25

-0.20

-0.15

-0.10

-0.05

0.00

0.05

0.10

0.15

Jan

-00

Oct

-00

Jul-

01

Ap

r-0

2

Jan

-03

Oct

-03

Jul-

04

Ap

r-0

5

Jan

-06

Oct

-06

Jul-

07

Ap

r-0

8

Jan

-09

Oct

-09

Jul-

10

Ap

r-1

1

Jan

-12

Oct

-12

Jul-

13

Ap

r-1

4

Jan

-15

Oct

-15

Jul-

16

Ap

r-1

7

Clearly, the Global Financial Crisis had a large impact in the economic growth of Germany, as in mid-2009 real GDP

declined by 7% on a YoY basis. However, the German economy returned to a sustainable growth path in late 2009.

On the other hand, Greek real GDP has deteriorated since 2009. During 2009 -2016 real GDP declined by 23%.

Consequently, the Relative Economic Activity Indicator plunged almost 4 times relative to its historical high recorded

in August 2009.


Real Effective Exchange RatesGreece vs Germany

Relative Cost Competitiveness Indicator (REL_CCOMP)

78

83

88

93

98

103

108

113

Jan

-00

Oct

-00

Jul-

01

Ap

r-0

2

Jan

-03

Oct

-03

Jul-

04

Ap

r-0

5

Jan

-06

Oct

-06

Jul-

07

Ap

r-0

8

Jan

-09

Oct

-09

Jul-

10

Ap

r-1

1

Jan

-12

Oct

-12

Jul-

13

Ap

r-1

4

Jan

-15

Oct

-15

Jul-

16

Ap

r-1

7

Greece REER SA Germany REER SA

-0.20

-0.15

-0.10

-0.05

0.00

0.05

Jan

-00

Oct

-00

Jul-

01

Ap

r-0

2

Jan

-03

Oct

-03

Jul-

04

Ap

r-0

5

Jan

-06

Oct

-06

Jul-

07

Ap

r-0

8

Jan

-09

Oct

-09

Jul-

10

Ap

r-1

1

Jan

-12

Oct

-12

Jul-

13

Ap

r-1

4

Jan

-15

Oct

-15

Jul-

16

Ap

r-1

7

Deterioration of Greek

competitiveness vs Germany

Improvement of Greek

competitiveness vs Germany

2nd Factor: Relative Cost Competitiveness Indicator

An increase in the real effective exchange rate implies that the economy is losing in terms of competitive advantage relative

to its external trade counterparts.

The relative competitiveness indicator deteriorated from 2000 to mid -2012. Since then the competitiveness of the Greek

economy relative to the German one has been gradually improving. In April 2017, the real effective exchange rate in Greece

decreased by 11.7% (improvement in competitiveness) relative to its highest levels (May 2011), when at the same period

the respective index in German declined by 6% (improvement in competitiveness). As a result, in April 2017 the Relative

Cost Competitiveness Indicator returned to levels observed at end - 2009.


Periphery 10Y Bond Yields vs Germany Benchmark

EA Periphery Risk Indicator(EAPER_RISK)

3rd Factor: EA Periphery Risk Indicator

16

We constructed the EA Periphery Risk Indicator, in order to map the average 10-Year bond spread of selected Euroarea periphery

countries (Portugal, Italy, Spain and Ireland) versus Germany and consequently the impact of peer countries on the Greek bond market.

Due to similar structural features underlying the economies of Euroarea periphery as well as the common sensitivity of these countries

to fiscal shocks, such as the EU debt crisis, there is a strong positive cross-correlation. The average periphery bond spreads were

materially low during 2000-2007, but increased dramatically after the global financial crisis and reached a peak in early 2012.

Bond spreads especially for Portugal and Ireland skyrocketed during the period 2011- 2012 when they were forced to agree to their

Economic Adjustment Programmes, signed in May 2011 and December 2010 respectively. However, the successful implementation of

the MoU’s in Portugal and Ireland and the ECB accommodative monetary policy, reduced the pressure and led to a gradual decline in

periphery bond spreads. Still, it is clear that this specific risk factor remains elevated compared to the pre-financial crisis period and has

recorded an upward trend in 2016 and the beginning of 2017.

0

100

200

300

400

500

600

700

800

Jan

-00

Oct

-00

Jul-

01

Ap

r-0

2

Jan

-03

Oct

-03

Jul-

04

Ap

r-0

5

Jan

-06

Oct

-06

Jul-

07

Ap

r-0

8

Jan

-09

Oct

-09

Jul-

10

Ap

r-1

1

Jan

-12

Oct

-12

Jul-

13

Ap

r-1

4

Jan

-15

Oct

-15

Jul-

16

Ap

r-1

7

0

2

4

6

8

10

12

14

16

18

Jan

-00

Oct

-00

Jul-

01

Ap

r-0

2

Jan

-03

Oct

-03

Jul-

04

Ap

r-0

5

Jan

-06

Oct

-06

Jul-

07

Ap

r-0

8

Jan

-09

Oct

-09

Jul-

10

Ap

r-1

1

Jan

-12

Oct

-12

Jul-

13

Ap

r-1

4

Jan

-15

Oct

-15

Jul-

16

Ap

r-1

7

Germany 10Y Yield Portugal 10Y Yield Italy 10Y YieldSpain 10Y Yield Ireland 10Y Yield


Debt to GDP ratio (%)Greece vs Germany

Relative Fiscal Sustainability Indicator (REL_FSCI)

4th Factor: Relative Fiscal Sustainability Indicator

40

60

80

100

120

140

160

180

Jan

-00

Oct

-00

Jul-

01

Ap

r-0

2

Jan

-03

Oct

-03

Jul-

04

Ap

r-0

5

Jan

-06

Oct

-06

Jul-

07

Ap

r-0

8

Jan

-09

Oct

-09

Jul-

10

Ap

r-1

1

Jan

-12

Oct

-12

Jul-

13

Ap

r-1

4

Jan

-15

Oct

-15

Jul-

16

Ap

r-1

7

Greece Debt to GDP Germany Debt to GDP

1.00

1.20

1.40

1.60

1.80

2.00

2.20

2.40

2.60

2.80

3.00

3.20

3.40

Jan

-00

Oct

-00

Jul-

01

Ap

r-0

2

Jan

-03

Oct

-03

Jul-

04

Ap

r-0

5

Jan

-06

Oct

-06

Jul-

07

Ap

r-0

8

Jan

-09

Oct

-09

Jul-

10

Ap

r-1

1

Jan

-12

Oct

-12

Jul-

13

Ap

r-1

4

Jan

-15

Oct

-15

Jul-

16

Ap

r-1

7

Fiscal sustainability usually plays an important role on the medium term fluctuations of financial variables since it is

related with the aggregate expectations for the country’s financing prospects.

In Greece, during the public debt crisis, the debt to GDP ratio surged, surpassing 170% in 2011. In sharp contrast, the

conservative fiscal policy of the German government and the low debt refinancing rates contributed to the downward

trend of the respective debt to GDP ratio after 2009. Consequently, the debt to GDP ratio in Germany decreased by more

than 10 ppts since 2009, while the respective Greek ratio increased by more than 50 ppts.

Following this trend, the Relative Fiscal Sustainability Indicator increased exponentially since 2007, reaching its highest

level in April 2017.


18







Econometric Specification of the GGB spreads QR Model

19

Optimal Specification of the GGB Spread Model

𝑄𝜏(𝐺𝐺𝐵𝑠𝑝𝑟𝑑𝑠𝑡) = 𝛽0,𝜏 + 𝛽1,𝜏𝑅𝐸𝐿_𝐸𝐶𝐴𝐶𝑇𝑡 + 𝛽2,𝜏𝑅𝐸𝐿_C𝐶𝑂𝑀𝑃𝑡 + 𝛽3,𝜏𝐸𝐴𝑃𝐸𝑅_𝑅𝐼𝑆𝐾𝑡 + 𝛽4,𝜏𝑅𝐸𝐿_𝐹𝑆𝐶𝐿𝑡

𝑓𝑜𝑟 𝑒𝑎𝑐ℎ 𝑞𝑢𝑎𝑛𝑡𝑖𝑙𝑒 𝜏 = 5𝑡ℎ , 10𝑡ℎ,… , 95𝑡ℎ

Where, REL_ECACT: Relative Economic Activity Indicator

REL_CCOMP: Relative Cost Competitiveness Indicator

EAPER_RISK: EA Periphery Risk Indicator

REL_FSCI: Relative Fiscal Sustainability Indicator


The Relative Economic Activity Indicator drives Upside Risk

20

The Relative Economic Activity Indicator (REL_ECACT) is

statistically significant (at a 5% confidence level) only in the

left tail of the spread distribution.

The regression coefficients (beta) have the expected sign,

stating a negative correlation between the Greek-German

economic activity gap and spreads. However, it tends to vary

across the different parts of spreads distribution.

In contrast to the OLS method, where the coefficient (beta) is

constant, under the QR method we observe a stronger

impact as we move towards the left tail of the spread

distribution.

In other words, the Relative Economic Activity Indicator is

more strongly associated with the probability of an

unexpected decline in Greek spreads (upside risk).

For example, an increase in the real GDP index in Greece

compared to the real GDP index in Germany, not only

implies a downward location shift for the spread

distribution but also a higher probability in observing lower

spreads.

0.2 0.4 0.6 0.8

300

500

700

900

(Intercept)

0.2 0.4 0.6 0.8

200

400

600

800

periphery

0.2 0.4 0.6 0.8

-50

050

100

150

reer

0.2 0.4 0.6 0.8

-600

-200

0200

rgdp

0.2 0.4 0.6 0.8

-400

0200

400

debt_gdp

Spread Distribution Quantiles

Bet

a C

oef

fici

ent

The solid red line indicates the beta estimate under OLS while the dash-dot black linedenotes the QR estimate. The area between the dashed red lines denote 95% confidenceintervals for OLS while the grey shaded area indicates the respective confidence interval forQR beta estimates.

Relative Economic Activity Indicator

(beta coefficient in each Spread Distribution Quantiles)


Competitiveness determines Upside Potential

21

Similarly, the Relative Cost Competitiveness Indicator

(REL_CCOST) is also statistically significant (at a 5%

confidence level) at the left tail of the spread distribution.

As expected, the sign of the coefficient (beta) indicates a

positive correlation between cost competitiveness and

bond spreads, i.e a decrease in the indicator

(improvement of Greece’s relative competitiveness)

increases the probability for a decline in Greek bond

spreads.

Notably, the OLS and QR estimation methods produce

quite different beta estimates as the two methods

produce betas with opposite signs.

0.2 0.4 0.6 0.8

300

500

700

900

(Intercept)

0.2 0.4 0.6 0.8

200

400

600

800

periphery

0.2 0.4 0.6 0.8

-50

050

100

150

reer

0.2 0.4 0.6 0.8

-600

-200

0200

rgdp

0.2 0.4 0.6 0.8

-400

0200

400

debt_gdp

Bet

a C

oef

fici

ent



Relative Cost Competitiveness Indicator



EA Periphery Risk is strongly associated with a Downside Risk

22

0.2 0.4 0.6 0.8

300

500

700

900

(Intercept)

0.2 0.4 0.6 0.8

200

400

600

800

periphery

0.2 0.4 0.6 0.8

-50

050

100

150

reer

0.2 0.4 0.6 0.8

-600

-200

0200

rgdp

0.2 0.4 0.6 0.8

-400

0200

400

debt_gdp

Bet

a C

oef

fici

ent


The solid red line indicates the beta estimate under OLS while the dash-dot black linedenotes the QR estimate. The area between the dashed red lines denote 95% confidenceintervals for Ols while the grey shaded area indicates the respective confidence interval forQR beta estimates.

The Relative EA Periphery Risk Indicator (EAPER_RISK) is

statistically significant (at a 5% confidence level) throughout

the whole spread distribution.

The regression coefficient (beta) states a positive correlation

between EA periphery risk and spreads. However, in

contrast, with the OLS method, where the coefficient (beta)

is constant, under the QR method we observe a gradually

increasing impact as we move from the left to the right tail of

the distribution.

In other words, the Relative EA Periphery Risk is likely more

strongly associated with the probability of an unexpected

increase in Greek spreads (downside risk).

Consequently, an increase in the periphery risk indicator not

only implies an upward location shift for the spread

distribution but also a higher probability in observing higher

GGB spreads.

Relative EA Periphery Risk Indicator



The Relative Fiscal Sustainability is related with spread volatility

0.2 0.4 0.6 0.8

300

500

700

900

(Intercept)

0.2 0.4 0.6 0.8

200

400

600

800

periphery

0.2 0.4 0.6 0.8

-50

050

100

150

reer

0.2 0.4 0.6 0.8

-600

-200

0200

rgdp

0.2 0.4 0.6 0.8

-400

0200

400

debt_gdp


Bet

a C

oef

fici

ent


The Relative Fiscal Sustainability Indicator (REL_FSCI) is

statistically significant (at a 10% confidence level) only at the

left tail of the spread distribution.

In the case of the relative Fiscal Sustainability, the sign of

the coefficient (beta) varies across quantiles, as it declares a

positive correlation between debt ratio and bond spreads

in the right tail of the spread distribution and a negative

correlation in the left tail.

This reversal of the impact across quantiles is related to the

Greek bond spread volatility. Specifically, an increase in

Relative Fiscal Sustainability (worsening in Greek debt ratio

compared to Germany) leads to a wider spread distribution

and therefore higher uncertainty about the actual bond

spread outcome.

Relative Fiscal Sustainability Indicator



Impact on Government Spreads from a 10% increase in each indicator

24

1. An improvement of the Greek GDP growth and competitiveness relative to Germany compresses GGB spreads almost at a uniformmanner across the distribution of spreads but the coefficients are statistically significant only at the low-end of the conditional spreadsdistribution.

2. The high impact of the Periphery Risk provides concrete evidence of contagion or systemic risk between EA periphery bond marketsand economies especially on the high-end of the spread distribution.

3. Increases in borrowing designate as more likely both the event of lower and higher bond spreads. This somewhat counterintuitiveoutcome indicates an increase in uncertainty about spreads possibly due to the fact that at different periods an increase in debt caneither be perceived as a sign of unexpected growth or as an episode associated with the difficulty of providing sustainabledisbursement of a funding tranche. In any case our model indicates that debt increases are associated with a more volatile path forGreek bond spreads.

Impact on Greek Government Spread from a 10% increase in …

8

8

8

9

10

11

12

12

10

10

10

9

7

6

6

5

3

7

9

-4

-5 0 5 10 15

Q5

Q10

Q15

Q20

Q25

Q30

Q35

Q40

Q45

Q50

Q55

Q60

Q65

Q70

Q75

Q80

Q85

Q90

Q95

OLS

impact (in basis points)

Relative Cost Competitiveness (Real Effective Exchange Rate)

21

23

25

26

27

27

27

28

32

32

35

35

38

43

44

46

56

53

61

47

-10 0 10 20 30 40 50 60 70

Q5

Q10

Q15

Q20

Q25

Q30

Q35

Q40

Q45

Q50

Q55

Q60

Q65

Q70

Q75

Q80

Q85

Q90

Q95

Least…


EA Periphery Risk(Periphery 10Y Spreads)

-5

-6

-6

-7

-7

-7

-7

-6

-5

-5

-5

-5

-3

-3

-3

-2

-1

-4

-11

-1

-15 -10 -5 0 5 10

Q5

Q10

Q15

Q20

Q25

Q30

Q35

Q40

Q45

Q50

Q55

Q60

Q65

Q70

Q75

Q80

Q85

Q90

Q95

Least Squares


Co

nd

itio

nal

Qu

anti

les

Relative Economic Activity (Real GDP)

-10

-17

-22

-32

-31

-27

-27

-19

-13

-4

4

19

29

32

32

37

52

50

-25

39

-50 -30 -10 10 30 50 70

Q5

Q10

Q15

Q20

Q25

Q30

Q35

Q40

Q45

Q50

Q55

Q60

Q65

Q70

Q75

Q80

Q85

Q90

Q95

Least Squares


Relative Fiscal Sustainability(Debt to GDP)


The added flexibility of our model allows us not only to assess its ability (solid blue line) to track the actual evolution of GGB

spreads (solid red line) over the period 2000-2017 but also to capture periods of substantial misalignments in the GGB market.

By plotting the area in which there is a 50% chance (90% chance) of occurrence of GGB spreads based on their fundamentals, we

can visually identify periods when actual spreads deviated substantially from their fundamentals.

Apparently in the run-up to the Greek crisis in 2008-2009 Greek bonds were substantially overpriced (spreads too low vs model

estimate) as well as in the period around 2013-2014.

On the contrary, extreme uncertainty led to record undervaluation of GGBs (spreads too high) in 2011-2012 as well as around

mid-2015. In all cases, prices corrected by returning into the middle of their theoretical range after a while.

25

GGB Spreads: A Fundamental based “Fair” Value

-500

0

500

1000

1500

2000

2500

3000

3500

4000

Jan

-06

May

-06

Sep

-06

Jan

-07

May

-07

Sep

-07

Jan

-08

May

-08

Sep

-08

Jan

-09

May

-09

Sep

-09

Jan

-10

May

-10

Sep

-10

Jan

-11

May

-11

Sep

-11

Jan

-12

May

-12

Sep

-12

Jan

-13

May

-13

Sep

-13

Jan

-14

May

-14

Sep

-14

Jan

-15

May

-15

Sep

-15

Jan

-16

May

-16

Sep

-16

Jan

-17

90% Confidence Bounds

50% Confidence Bounds

Median Estimate

Actual vs Fitted Spread Distribution


26








27

-50

-40

-30

-20

-10

0

10

20

30

40

50

Jan

-00

Oct

-00

Jul-

01

Ap

r-0

2

Jan

-03

Oct

-03

Jul-

04

Ap

r-0

5

Jan

-06

Oct

-06

Jul-

07

Ap

r-0

8

Jan

-09

Oct

-09

Jul-

10

Ap

r-1

1

Jan

-12

Oct

-12

Jul-

13

Ap

r-1

4

Jan

-15

Oct

-15

Jul-

16

Ap

r-1

7

Market Complacency

Market Stress

Greek bond market was under severe stress during 2011-2012

with market valuations very close to the upper bound

Market stress resumed after 2014, but gradually converged to more “fair” market valuations.

Greek bond market was characterized by relative complacency in April 2017, with a tendency to overvalue Greek bonds. However index boundary levels suggest that bond markets remain anchored near the “fair” value range implied by the model.

We construct the Greek Bond Market Misalignment Index which depicts the past evolution as well as the current level of

market assessment about the Greek Bond Market. By construction the index is bounded between 50 and -50 points. When the

index moves close to its 50 ceiling (i.e. market valuations start to deviate positively from the model’s “fair” value) the Greek

bond market is under stress and Greek government bonds are undervalued. In contrast, negative values suggest that the bond

market overvalues Greek government bonds probably due to greater confidence about the Greek economy future prospects.



28







Value at Risk and GGBs

29

Value at Risk (VaR) estimates are perhaps the key input in the risk management decision process. Since this measure relates to the

odds of an extreme surge in bond spreads it can be considered as a worst-case scenario for Greek bonds.

However, as implied by the differences in the VaR estimates between the least squares and QR regression, the two methods result

in economically important deviations. Specifically, the standard least squares consistently indicated higher VaR 90% estimates

relative to QR for the period starting from 2000 up to 2010. Similarly, least squares estimates were on average more than 180 bps

lower than QR in the post-crisis period.

As a result, the QR methodology dictates a considerably different stance when making risk management decision. In periods of low

market stress QR signals a more benign stance relative to more standard estimates, while in periods of high market stress it

indicates a more conservative stance towards risk.

-350

-150

50

250

450

650

850

-1100

-600

-100

400

900

1400

1900

2400

2900

Jan

-00

Oct

-00

Jul-

01

Ap

r-0

2

Jan

-03

Oct

-03

Jul-

04

Ap

r-0

5

Jan

-06

Oct

-06

Jul-

07

Ap

r-0

8

Jan

-09

Oct

-09

Jul-

10

Ap

r-1

1

Jan

-12

Oct

-12

Jul-

13

Ap

r-1

4

Jan

-15

Oct

-15

Jul-

16

Ap

r-1

7

Difference (RHS) QR VaR 90% OLS VaR 90%

QR model more conservative

OLS model more conservative

90% Value at Risk Estimates


…Balance of Risks Indicator

30

From the Fair-Valuation chart on page 25, the careful reader would have realized that the 50% & 90% confidence bounds

are not symmetric around the median estimate. The direct implication of that asymmetry is that our model specification

can provide not only an indicator of the fair-valuation of GGBs but also an assessment of the directional balance of risks

around the fair-value estimate. According to the Balance of Risk Indicator positive values imply increased risks for higher

spreads (downside risk for GGBs). Conversely, negative values signal increase possibility for lower spreads creating

potential for GGBs. The index shows that the Greek bond market was under severe pressure after 2009 with the model

signaling that risk was skewed towards the left tail (downside risk) of the implied spread distribution. In April 2017, the

indicator shows that risks remain balanced towards wider Greek bond spreads.

-0.2

-0.15

-0.1

-0.05

0

0.05

0.1

0.15

0.2

0.25

Jan

-00

Oct

-00

Jul-

01

Ap

r-0

2

Jan

-03

Oct

-03

Jul-

04

Ap

r-0

5

Jan

-06

Oct

-06

Jul-

07

Ap

r-0

8

Jan

-09

Oct

-09

Jul-

10

Ap

r-1

1

Jan

-12

Oct

-12

Jul-

13

Ap

r-1

4

Jan

-15

Oct

-15

Jul-

16

Ap

r-1

7

Risks tilted to higher spreadsBond - negative

Risks tilted to lower spreadsBond - positive

Balance of Risks Indicator


A “Fair” Value on Bond Spread Volatility

QR 80% Confidence Intervals

Least Squares 80% Confidence Interval

During the period before 2009, the model-implied 80% confidence

bounds for Greek bond spreads ranged between 160-345 bps.

Immediately after the first Economic Adjustment Programme signed

in May 2010 model estimates pointed to a much wider range

between 520 – 1024 bps. Greek bond volatility (and hence the width

of the confidence bound) increased gradually, peaking in early 2011.

Seven years later, in April 2017, the implied uncertainty in Greek

bond spreads lies at approximately the same levels as in June 2010.

Evidently, a “fair” value for the volatility in bond spreads is more

accurate and intuitively less prone to irrational interpretations

compared to the OLS estimates. Specifically, least squares bounds

are wider (higher volatility) than the QR bounds in the pre-crisis

period and considerably lower than QR bounds in the post-crisis

period. Consequently, standard regression methods overestimate

volatility under normal circumstances and underestimate volatility

in periods of severe market stress.

Furthermore, the estimated lower bound under OLS is negative for

Greek bond spreads, implying that Greek 10-Year yields could be

lower than the respective yields for German bonds of the same

maturity. On the contrary, the lower bound under QR is always

positive and thus more sensible in terms of economic intuition.

-500

0

500

1000

1500

2000

2500

3000

3500

4000

Jan

-00

Oct

-00

Jul-

01

Ap

r-0

2

Jan

-03

Oct

-03

Jul-

04

Ap

r-0

5

Jan

-06

Oct

-06

Jul-

07

Ap

r-0

8

Jan

-09

Oct

-09

Jul-

10

Ap

r-1

1

Jan

-12

Oct

-12

Jul-

13

Ap

r-1

4

Jan

-15

Oct

-15

Jul-

16

Ap

r-1

7

Lower Upper

-800

-300

200

700

1200

1700

2200

2700

3200

Jan

-00

Oct

-00

Jul-

01

Ap

r-0

2

Jan

-03

Oct

-03

Jul-

04

Ap

r-0

5

Jan

-06

Oct

-06

Jul-

07

Ap

r-0

8

Jan

-09

Oct

-09

Jul-

10

Ap

r-1

1

Jan

-12

Oct

-12

Jul-

13

Ap

r-1

4

Jan

-15

Oct

-15

Jul-

16

Ap

r-1

7

Lower Upper


32







Bond Spread Projection over the next 6 –months:

Scenario Assumptions

33

The scenario is constructed upon the assumptions that:

The Relative Economic Activity indicator is assumed to improve as the Greek economy will return togrowth and real GDP increases by 0.7%. For Germany we assume a 1.5% YoY growth rate.

The Relative Cost Competitiveness Indicator will increase as a more hawkish ECB policy affects exportoriented countries such as Germany more compared to Greece, causing only the German REER toincrease by 1% on a monthly basis for the next 6 months.

The Relative EA Periphery Risk Indicator will decline gradually towards 2014 levels as the German 10 -Year yield will increase faster than the yields in the periphery. Moreover the ECB will continue the QEprogramme in 2017 for the periphery in order to support economic growth prospects for peripherycountries in 2017.

The Relative Fiscal Sustainability Indicator will remain unchanged as the debt ratios will remain stable atcurrent levels over the next 6 months.


Assumptions – EA Periphery Risk Indicator Assumptions - Relative Fiscal Sustainability Indicator

Assumptions - Relative Economic Activity Indicator Assumptions - Relative Cost Competitiveness Indicator

Bond Spread Projection: Scenario Assumptions

-0.12

-0.10

-0.08

-0.06

-0.04

-0.02

0.00

0.02

82

84

86

88

90

92

94

96

98

100

102

Jan-1

3

Ap

r-13

Jul-1

3

Oct-1

3

Jan-1

4

Ap

r-14

Jul-1

4

Oct-1

4

Jan-1

5

Ap

r-15

Jul-1

5

Oct-1

5

Jan-1

6

Ap

r-16

Jul-1

6

Oct-1

6

Jan-1

7

Ap

r-17

Jul-1

7

Oct-1

7

GR reer DE reer Relative Competitiveness (RHS)

-0.34

-0.32

-0.30

-0.28

-0.26

-0.24

-0.22

-0.20

-0.18

75

80

85

90

95

100

105

110

115

Jan-1

3

Ap

r-13

Jul-1

3

Oct-1

3

Jan-1

4

Ap

r-14

Jul-1

4

Oct-1

4

Jan-1

5

Ap

r-15

Jul-1

5

Oct-1

5

Jan-1

6

Ap

r-16

Jul-1

6

Oct-1

6

Jan-1

7

Ap

r-17

Jul-1

7

Oct-1

7

GR RGDP DE RGDP Relative Economic Activity (RHS)

0

50

100

150

200

250

300

350

400

450

500

Jan-1

3

Ap

r-13

Jul-1

3

Oct-1

3

Jan-1

4

Ap

r-14

Jul-1

4

Oct-1

4

Jan-1

5

Ap

r-15

Jul-1

5

Oct-1

5

Jan-1

6

Ap

r-16

Jul-1

6

Oct-1

6

Jan-1

7

Ap

r-17

Jul-1

7

Oct-1

7

34

2.20

2.40

2.60

2.80

3.00

3.20

3.40

40

60

80

100

120

140

160

180

200

Jan-1

3

Ap

r-13

Jul-1

3

Oct-1

3

Jan-1

4

Ap

r-14

Jul-1

4

Oct-1

4

Jan-1

5

Ap

r-15

Jul-1

5

Oct-1

5

Jan-1

6

Ap

r-16

Jul-1

6

Oct-1

6

Jan-1

7

Ap

r-17

Jul-1

7

Oct-1

7

GR Debt Ratio DE Debt Ratio Relative Fiscal Sustainability (RHS)


Bond Spread Projection: 6-month Confidence Regions

According to the scenario assumptions for the underlying factors of Greek bond spreads, there is a 20%

chance that spreads will lie in the range 460-720 bps until November 2017.

Nevertheless, the risk for higher spreads is still substantial and negative surprises may lead bond spreads

towards the 900-1100 bps range while based on the model’s projections there is only a 10% probability that

spreads will fall below 400 bps over the next 6 months.

300

400

500

600

700

800

900

1000

1100

1200

1300

1400

1500

300

400

500

600

700

800

900

1000

1100

1200

1300

1400

1500

Jan-1

3

Ap

r-13

Jul-1

3

Oct-1

3

Jan-1

4

Ap

r-14

Jul-1

4

Oct-1

4

Jan-1

5

Ap

r-15

Jul-1

5

Oct-1

5

Jan-1

6

Ap

r-16

Jul-1

6

Oct-1

6

Jan-1

7

Ap

r-17

Jul-1

7

Oct-1

7

90% Confidence 50% Confidence 20% Confidence Spread

Bond Spread Projection


36

Disclaimer: This document is produced by the Economic Research & Investment Strategy Department of Piraeus Bank (hereinafter "the Bank"), which is supervised by the European Central Bank

(ECB), in collaboration with the Bank of Greece and is sent or provided to third parties, without any obligation of its author. This document or any part of it should not be duplicated in any way

without the prior written consent of its author.

The information or opinions included in this document are addressed to existing or potential clients in a general manner, without taking into account the particular circumstances, the investment

objectives, the financial ability, the experience and/or knowledge of the potential recipients of this document and, as a result, they do not constitute or should not be considered neither as a

solicitation or offer for the conduct of transactions in financial instruments or currencies nor as a recommendation or advice for decision making in relation to those. Taking into account the

aforementioned, the recipient of the information contained in this document should proceed with his/her own research, analysis, and confirmation of the information which is included in this

document and seek for independent and professional legal, tax and investment advice, before proceeding with any investment decision making.

The information depicted in this document is relied on sources that the Bank considers to be reliable and is provided on an "as is" basis, however, the Bank cannot warrant as to their accuracy and

completeness. The opinions and estimates herein are related to the trend of the local and international financial markets at the indicated date (prices at closing time) and are subject to changes

without any prior notice. Notwithstanding the above, the Bank might include in this document investment researches, which have been conducted by third persons. In this case, the Bank does not

modify those researches, but it presents them on an "as is" basis, therefore, no responsibility is assumed in relation to the content of the aforementioned investment researches. The Bank is under

no duty to update the information contained in this document. Considering the above, the Bank, the members of its Board of Directors and the relevant persons assume no responsibility for the

information included in the present document and/or for the outcome of any investment decisions made according to such information.

Piraeus Bank Group is an organisation with a significant presence in the Greek market and an increasing one in the international markets providing a wide range of investment services. In the

context of investment services offered by the Bank and/or any other Piraeus Group companies in general, there might be cases whereby conflict of interests may arise in relation to the information

provided herein. Reference should be made to the fact that the Bank, the relevant persons and/or other Piraeus Group companies indicatively:

a. Are not subject to any prohibition in relation to trading on own account or in the course of providing portfolio management services prior to the publication of this

document or the acquisition of any shares prior to any public offering or the acquisition of any other securities.

b. May offer upon remuneration investment banking services to issuers for whom this document may contain information.

c. May participate to the issuers' share capital or acquire other securities issued by the aforementioned issuers or attract other financial interests from them.

d. Might provide market making or underwriting services to issuers that might be mentioned in this document.

e. Might have published papers the content of which is different or incompatible to the information presented herein.

The Bank as well as the other Piraeus Group's companies have enacted, implement and maintain an effective policy, which prevents circumstances that may give rise to conflicts of interests and

the dissemination of any information among the departments ("chinese walls") and they also constantly comply with the provisions and regulations relevant to inside information and market

abuse. Also, the Bank confirms that it doesn't have any kind of interest or conflict of interest with a) any other legal entity or person that could have participated in the preparation of the present

document and b) with any other legal entity or person that couldn't have participated in the preparation of the present document, but had access to it before its publication.

It is duly stated that: the investments described in the present document include investment risks, among which the risk of losing the entire capital invested. In particular, it is stated that;

a. The figures presented herein refer to the past and that the past performance is not a reliable indicator of future performance.

b. In case the figures refer to simulated past performance, that past performance is not a reliable indicator of future performance.

c. The return on investments might be positively or negatively affected as a result of currency fluctuations, in case the figures are denominated in a foreign currency (other than

Euro).

d. Any forecasts in relation to future performance, may not be a reliable indicator of future performance.

e. The tax treatment of the information as well as transactions pertained in this document, depends on each investor's individual circumstances and may be subject to change in

the future. As a result, the recipient should seek for independent advice in relation to the applicable tax legislation.

The distribution of the present document outside Greece and/or to persons governed by foreign law may be subject to restrictions or prohibitions according to the applicable legislation.

Therefore, the recipient of the present should seek for independent advice in relation to the applicable legislation, in order to look into such restrictions and/or prohibitions.

Understanding greek government bond spreads

Economy & Finance

Transcript of Understanding greek government bond spreads