ABSTRACT
The large shocks to the Greek sovereign bond markets during the recent European debt crisis stunned the market participants. This is primarily because there is a convention of treating government bonds as risk-free instruments, based on a sovereign entity’s ability to either raise taxes, cut spending, print money, or some combination of the three. Until recently, government debt instruments in developed nations had been regarded as a proxy for the unobservable risk-free rate (e.g. Blanco et al., 2005 Delis and Mylonidis, 2011). Since the introduction of the Euro and until the onset of the recent financial crises, many investors believed Eurozone government bonds behaved as if they were free of country-specific risks (e.g. Oliveira et al., 2011).
