How QE changes the nature of sovereign risk

We examine the effect of Quantitative Easing (QE) by the ECB on the sovereign bond risks of Italy, Ireland, Spain and Portugal. First, outcomes of panel regression models suggest that QE lowered the effect of volatility on sovereign bond spreads by 1 to 2 percentage points. Compared to asset purchases aimed at easing the monetary stance, purchase programmes supporting monetary transmission by countering financial market stress most clearly reduced the effect of volatility on spreads. Second, using a contingent claims model (CCM), the values of the implicit put options provided by QE as a backstop to investors are calculated to be substantial. Our results guide policymakers on the use of backstop facilities for sovereign bond markets.

Keywords: Quantitative Easing, Sovereign risk, Sovereign spreads, Contingent Claims Model
JEL codes E52, E58, G12

Working paper no. 737