What uncertainty does to euro area sovereign bond markets: Flight to safety and flight to quality

We use a panel of 10 euro area countries over the period 1996Q1-2017Q4 to show that heightened uncertainty leads to (i) a flight to "safety" and (ii) a flight to "quality" in sovereign bond markets. Global, macroeconomic and the common euro area uncertainty outperform country-level, financial and euro area idiosyncratic uncertainty in forecasting sovereign bond risk premia, respectively. A rise in economic policy uncertainty also pushes investors to demand a disproportionately larger premium to hold "risky" bonds versus the "safe-haven" bond. Finally, business and economic related uncertainty is of first-order importance, while politics and government uncertainty plays a somewhat secondary role. Our results are robust to yield curve inversions, risk rating metrics, (non-standard) monetary policy conditions and the occurrence of sovereign debt crises.(c) 2021 Elsevier Ltd. All rights reserved.