Eurozone government bond spreads: A tale of different ECB policy regimes

We aim to determine Eurozone sovereign bond spreads and the ECB's influence through a generalised model. In a multidimensional structure we regress an extensive set of variables for different factors on spreads, and empirically identify the best-fit through a general-to-specific process. We cannot identify a satisfactory specification with macro fundamental factors. Different regimes in the spreads' structure explains this. Spreads are after 2012/2013 well explained by market risk-based factors, and our specification is robust for earlier periods. When we add EMU-specific factors, it is shown that Target2 balances reduce spread as they increase convertibility risk costs until 2012/2013, and that the ECB's asset purchases subsequently reduce spreads, especially in the periphery. The break between these two periods coincides with an alteration of policy over two sets of Presidencies: Duisenberg - Trichet in the first period and Draghi-Lagarde in the second. Either set has interpreted and implemented the mandate of the central bank in a very different way. While under Duisenberg-Trichet the ECB has only acted in the Eurozone money market, under Draghi-Lagarde the central bank has increasingly been involved in the capital market.