We estimate the 'fundamental' component of euro area sovereign bond yield spreads, i.e. the part
of bond spreads that can be justified by country-specific economic factors, euro area economic
fundamentals, and international influences. The yield spread decomposition is achieved using a
multi-market, no-arbitrage affine term structure model with a unique pricing kernel. More
specifically, we use the canonical representation proposed by Joslin, Singleton, and Zhu (2011) and
introduce next to standard spanned factors a set of unspanned macro factors, as in Joslin,
Priebsch, and Singleton (2013). The model is applied to yield curve data from Belgium, France,
Germany, Italy, and Spain over the period 2005-2013. Overall, our results show that economic
fundamentals are the dominant drivers behind sovereign bond spreads. Nevertheless, shocks
unrelated to the fundamental component of the spread have played an important role in the
dynamics of bond spreads since the intensification of the sovereign debt crisis in the summer of
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