Modelling asymmetric sovereign bond yield volatility with univariate GARCH models: Evidence from India

Abstract

Does Indian sovereign yield volatility reflect economic fundamentals, or whether it is a self-generated force flowing through markets with little connection to such fundamentals? To answer the question, this research explores the volatility dynamics and measures the persistence of shocks to the sovereign bond yield volatility in India from 1 January 2016, to 18 May 2022, using a family of GARCH models. The empirical results indicate the high volatility persistence across the maturity spectrum in the sample period. However, upon decomposing the markets into bull and bear phases, our results support the existence of weak volatility persistence and rapid mean reversion in the bear market. This shows that the economic response policies implemented by the government during the pandemic, including fiscal measures, have a restraining effect on sovereign yield volatility. For a positive γ, the results suggest the possibility of a “leverage effect” that is markedly different from that frequently seen in stock markets. Results further indicate that the fluctuations in Indian sovereign yields cannot be dissociated from inflation and money market volatility. Our findings herein provide valuable information and implications for policymakers and financial investors worldwide.

Keywords:

• sovereign bond yield
• volatility
• leverage
• symmetric GARCH
• COVID-19
• mean reversion

JEL Classifications:

• C22
• C52
• E430
• E440
• G10
• G17

PUBLIC INTEREST STATEMENT

The Indian financial system is changing fast, marked by strong economic growth, more robust markets, and considerably greater efficiency. Thus, analyzing the volatility of sovereign bond yields across maturities in India is worthwhile. The findings emphasize that positive shocks tend to cause volatility to rise as opposed to negative shocks of equal magnitude. The Indian financial markets, however, have recovered more quickly from the negative impact on sovereign yields post-pandemic. The market overreaction theory and market correction theory underlie the collapse and fast recovery of the markets. Besides, the results show evidence for high volatility persistence; when it rises, it remains high for a considerable time and returns to its mean only gradually in a euphoric period. Finally, the link between movements in bond yields and fundamental economic forces is examined in the current study.

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

1. In fact, this was an explicit policy of rating agencies until 1997. Although this relationship persisted after 1997, empirically document it. In a recent paper, examine the influence of sovereign risk on corporate risk in emerging markets with option-adjusted spreads. More recently, examined the characteristics of bonds rated higher than their sovereigns.

2. There is a reason why sovereign credit risk spills over to corporate credit risk, which is called the “transfer risk”: By increasing corporate taxes, imposing foreign exchange controls, and even expropriating private investment, a government in financial distress will likely shift the debt burden onto corporations.

3. Stationarity results for Sovereign yields quarterly series are reported in Appendix 1.

4. The results of GARCH (1,1), IGARCH and GJR-GARCH are reported in Appendx 2, 3, 4, and 5.

5. A bear market is colloquially regarded as one where the stock market decreases by more than 20%. In the case of the COVID-19 crisis this initial decline occurred between 13th February and 12th March 2020.

6. To measure the volatility for sovereign yields and 3-month LIBOR, we follow (O’sullivan & Papavassiliou, 2019) and measure volatility by the standard deviation for each series.

7. The number of lags used in Granger Casualty test for each series is 2.

Additional information

Funding

The authors received no direct funding for this research.

Notes on contributors

Lithin B M

Lithin B M (First Author) is a Doctoral Scholar. His area of research is corporate finance and is currently pursuing his Ph.D. from theManipal Academy of Higher Education, Manipal, India

Suman Chakraborty

Suman Chakraborty (Corresponding Author) is working as an Associate Professor at the Department of Commerce, Manipal Academy of Higher Education, India. His research areas are Corporate Finance, Financial Markets, and Business Valuation.

Vishwanathan Iyer

Vishwanathan Iyer is a senior Associate Professor in the area of Accounting and Finance and currently the Dean (Accreditation) at the Great Lakes Institute of Management. His research interests are Portfolio Optimization, Earnings Management, Information content of text-based narrative in Annual reports, and the role of inspirational potency in communication to stock market participants.

Nikhil M N

Nikhil M N is currently pursuing his Ph.D. from the Department of Commerce, Manipal Academy of Education, Karnataka, India. Nikhil’s research is on capital structure and firm performance.

Sanket Ledwani

Lithin B M (First Author) is a Doctoral Scholar. His area of research is corporate finance and is currently pursuing his Ph.D. from theManipal Academy of Higher Education, Manipal, India

Sanket Ledwani is currently pursuing his Ph.D. from the Department of Commerce, Manipal Academy of Education, Karnataka, India. Sanket’s research is on Equity Level expected returns and Earnings Predictability.