Euro Zone Convergence, Divergence...And then What?

27 Pages Posted: 30 May 2017

See all articles by Francis E. Warnock

Francis E. Warnock

University of Virginia - Darden Business School; National Bureau of Economic Research (NBER)

Peter Marcel Debaere

University of Virginia - Darden School of Business; Centre for Economic Policy Research (CEPR)

Date Written: February 22, 2013

Abstract

A hedge-fund strategist had two decisions to make. First, what was the path of core euro zone long-term interest rates likely to be over the next year? Was the dramatic decline in German long rates over the past few years an aberration that would soon be reversed, or was it part of the “new normal” that would persist for some time? Second, how would periphery long rates evolve relative to core rates? That is—the spread between long rates in the likes of Greece, Spain, and Ireland and those in Germany—how would they evolve over the next year? Was the dramatic divergence in euro zone long rates likely to persist, or would the coming year see a continuation of the modest reconvergence that has occurred since mid-2012? He knew many factors influenced long-term interest rates; he would have to use his entire toolkit to address this issue. The evidence was in no way clear-cut. Some factors pointed toward lower German rates, some toward higher, some toward a widening of euro zone spreads (even a dissolution of the euro zone as we know it?), and some toward reconvergence.

Excerpt

UVA-GEM-0107

Rev. Feb. 22, 2013

Euro zone convergence, divergence…and then What?

As Arturo Rodrigo was riding the early morning Metro North train from Manhattan to Greenwich, Connecticut, in early February 2013, euro zone debt markets dominated his thoughts. Rodrigo was old enough to remember the dramatic convergence in euro zone long-term rates that occurred in the late 1990s just prior to the advent of the euro. The long rates of Italy and many other euro zone countries decreased sharply, converging down to the much lower German rates (Figure 1). This unprecedented decrease in borrowing costs fueled borrowing binges in Athens, Madrid, Dublin, and many other euro zone cities.

Figure 1. Long-term bond yields (through mid-2007).

Note: All figures/exhibits created by case writer.

. . .

Keywords: eurozone, debt markets, long-term interest rates

Suggested Citation

Warnock, Francis E. and Debaere, Peter Marcel, Euro Zone Convergence, Divergence...And then What? (February 22, 2013). Darden Case No. UVA-GEM-0107, Available at SSRN: https://ssrn.com/abstract=2974620

Francis E. Warnock (Contact Author)

University of Virginia - Darden Business School ( email )

P.O. Box 6550
Charlottesville, VA 22906-6550
United States
434-924-6076 (Phone)

HOME PAGE: http://faculty.darden.virginia.edu/warnockf/index.htm

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138-5398

Peter Marcel Debaere

University of Virginia - Darden School of Business ( email )

P.O. Box 6550
Charlottesville, VA 22906-6550
United States

HOME PAGE: http://www.darden.virginia.edu/html/direc_detail.aspx?styleid=2&id=5794

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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