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Analysis Of an Overstimulated Credit Expansion and Its Risks On Italy’s Fixed Income Market
Nr. | Chapter | Page. |
Abstract | 2 | |
Table of Contents | 3 | |
Introduction | 4 | |
1. | Literature review | 6 |
1.1. | The build-up of high levels of public debt | 6 |
1.2. | Economic theory synopsis | 9 |
1.3. | Empirical analysis | 11 |
1.4. | Debt sustainability analysis | 14 |
2. | Methodology | 15 |
2.1. | Study of the relationship between Debt and Yield via multiple regression model | 16 |
2.2. | Debt sustainability diagnosis | 20 |
3. | Descriptive analysis of data | 22 |
4. | Results | 22 |
4.1. | Study of yield drivers with emphasis on debt | 22 |
4.2. | Debt sustainability analysis and forecast of debt growth | 30 |
Conclusions | 35 | |
Appendices | 37 | |
Appendix A: Data file | 37 | |
Appendix B: Data sources and description of variables | 37 | |
References | 48 |
It is important to apprise the consequences of rapid credit expansion on the bond
market considering the size and far-reaching fallout if debt becomes unsustainable. Many
studies have attempted to find the value drivers of long-term interest rates (Kumar &
Baldacci, 2010), which, effectively, explains the biggest part of variance in yield, but none
(that we know of) have been able to contain the relationship between public debt level and
yield in one number. Yield is often referred to as an economic barometer since it incorporates
many factors in its value – credit risk, expected inflation and prevailing interest rate
environment (Kumar et al, op.cit). Higher yield means higher debt servicing costs for the
government, which means more debt issuance, as a result the compounding power of this
vicious cycle can be devastating. We focus on Italy-specific factors that go into the bond
yield equation, such as, budget balance, productivity, maturity, and net debt, thereby
mitigating the bias that usually stems from applying conventional approach to extreme cases.
It allows us to extract useful information from data with a lot of white noise and draw
conclusions about what exactly drives the value of yields in Italy, and if high levels of public
debt really affect the fixed-income market. So, the first research question we will attempt to
answer is: What factors impact the bond yield in Italy? International market headlines “Debtladen Italy finds itself in markets' crosshairs again” (Reuters, 2022) and “The Last Thing the
World Needs Is an Italian Debt Crisis” (Barron’s, 2022) makes it obvious that the world is
watching closely and waiting how the situation in Italy’s credit market will unfold, therefore,
we have revised hypothesis for the first research question.…
The study of the fixed-income market in Italy attempts to establish a list of unique and systematic factors affecting the performance of debt instruments with focus on overstimulated credit market expansion. The authors explain the theoretical foundation behind the evolution of public debt and its accumulation since the early 1990s, then revise and implement regression models to study value drivers of 10-year Italy Government Bond yield by applying VAR, multivariate regression model and impulse response functions based on Italy-specific macroeconomic settings. This paper analyses debt sustainability in Italy and forecasts debt-to-GDP ratio 4 years ahead. Key focus of the research is to distinguish what elements contribute to the performance of the fixed-income market, determine if public debt affects the bond market performance both in the short and long run, and draw conclusions about credit market risk profiles in Italy.
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