Cointegration of EMU Government Bonds in Times of Financial Crises, COVID-19, and High Inflation – The Importance of Sovereign Debt for the European Insurance Industry

Abstract

This paper is an empirical investigation of the long-term relationship between the yields of 10y sovereign bonds of Germany and ten European Monetary Union (EMU) member countries before, after, and during the most important financial and economic events since the Global Financial Crisis. Further, we investigate the long-term relationship of EMU bond yields in the most recent period of high inflation. We analyze daily 10y sovereign bond yields for both, sample and sub-samples, by implementing the Johansen parametric standard approach in cointegration testing in combination with two non-parametric test procedures suggested by Bierens (1997) and Breitung (2002), which are not dependent on nuisance parameters. The results indicate that there is strong evidence for cointegrating relationships in the sovereign bond yields in core and non-core Eurozone countries in the early period of the EMU. However, contradictory evidence is found in the sub-samples following the European Sovereign Debt Crisis, as well as in the more recent period of sharp increases in inflation which is experienced globally. The findings are especially relevant for the asset management of European insurance companies, predominantly with regard to the treatment of EMU sovereign debt within the European regulatory framework, namely the Solvency II Directive.