Government Bond Yields
Andrew Clare
and Nicolas Schmidlin1
The Sir John Cass Business School, City University, London, UK.
March 2014
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Abstract
The European debt-crisis and Greece’s government debt restructuring in 2012 in particular,
have highlighted the importance of the law governing bonds for investors and authorities alike.
Sovereign bonds issued under foreign law are generally harder to restructure given the issuers’
limited ability to change bond terms without the consent of a qualified majority or even the
entirety of bondholders. In contrast, local law bonds can be restructured by simply changing
domestic law. This paper examines the impact of the governing law on European government
bond yields between 2008 and 2012. We find strong evidence to suggest that bonds issued
under foreign law trade at a premium when political risk and restructuring risk are at their
greatest. We find that the size of this premium can be used as a direct measure of restructuring
or ‘breach-of-contract’ risk in government bond markets. We find that the average premium
paid for foreign law bonds, as compared to bonds governed by local law, peaked at 262bp in
terms of yield during the height of the crisis, when the very future of the Eurozone was at stake.
However, by the end of 2012 investors seemed once again to be factoring a very low level of
restructuring risk, despite the fact that between 88% and 100% of each Eurozone members’
debt is currently issued under local law. Our view is that investors in Eurozone government
debt would do well to remember the phrase: ‘caveat emptor’.
JEL classification: F34; G01; K00
Keywords: Foreign governing bond law; Eurozone government bonds; Eurozone crisis
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