Analysis Of an Overstimulated Credit Expansion and Its Risks On Italy’s Fixed Income Market

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.…