Comparative Analysis of Risk in Euro-Area Sovereign Yields

What risk premia exist in Euro-area sovereign yields, and how big are they? What are the similarities and differences across countries? This paper aims to answer these questions for eight Euro countries by using Kalman filtering to decompose their sovereign yields into the following premia: a short-rate and term premium, a default premium, a liquidity premium, and a segmentation premium. The main finding is that countries with similar credit ratings and yield magnitudes tend to exhibit similar patterns, and that on average, countries that were especially affected by the European Debt Crisis (Italy, Portugal, Spain) tend to have default premia that account for more than 50% of their sovereign yields.