Government bond yields respond to developments both at home and abroad. But what drives their volatility in Central and Eastern European countries—global financial markets, developments in the euro area, or domestic events? And did two major crises of recent years—the COVID-19 pandemic and Russia’s invasion of Ukraine—change this?
Jakub Čery and Martin Alexy from the Faculty of National Economy, in their study published in the journal Eastern European Economics, analyse developments in 10-year government bond yields across six Central and Eastern European countries. Their findings reveal substantial differences between euro-area countries and those with their own currencies. While the pandemic primarily caused short-term fluctuations, the outbreak of the war in Ukraine significantly increased the importance of domestic factors, particularly in Poland, Czechia, and Hungary. We spoke with the authors about why euro-area membership matters, what financial market “contagion” means, and what investors and economic policymakers can learn from their findings.
Let's start with the basics. What do we mean by government bond yield volatility, and why is it important to understand where this volatility comes from?
Every asset traded on financial markets, whether stocks, commodities, or cryptocurrencies, exhibits some degree of volatility. Put simply, volatility describes how much an asset's price or return fluctuates over time. The principle is similar for government bonds—their prices are determined by the market, and bond yields can be derived from these prices. From a portfolio and risk management perspective, it is important not only to account for asset volatility but also to understand its sources.
If investors know what drives volatility, they can better hedge their bond portfolios, design more effective stress tests, or choose alternative assets. For economic policymakers, understanding which factors influence domestic bond yields is equally important, as it can help them plan government budgets and sovereign debt issuance.
The challenge is that most smaller economies, including those in Central and Eastern Europe (CEE), are integrated into global financial markets to some extent. When major global events occur, these economies are often more like passengers than drivers. It is therefore unclear how much volatility spills over from global markets into CEE countries and how much originates within domestic markets. Domestic volatility may reflect political and economic developments, monetary policy, or inflation expectations. Distinguishing between global, regional, and local sources of volatility is precisely one of the main objectives of our research.
What do your findings reveal for the entire period under study? What are the most significant differences between euro-area countries and those that have retained their own currencies?
We examined six Central and Eastern European countries: Slovakia, Slovenia, Czechia, Poland, Romania, and Hungary. We decomposed the volatility of benchmark 10-year government bond yields into three components: a global component, represented by the US 10-year Treasury yield; a regional component, represented by the German Bund yield; and a local component, which captures the portion of volatility not explained by these two external sources.
Looking at the entire period, we already observe substantial differences across countries. The global factor was particularly important for Slovakia, Poland, and Czechia, where it explained approximately 40% of total volatility. By contrast, Hungary and especially Romania exhibited considerably larger shares of locally driven volatility.
However, the most striking difference between euro-area countries and those with their own currencies concerns the regional, or German, factor. In Slovakia and Slovenia, it accounted for approximately 22% of total volatility, whereas in countries outside the euro area, its share was generally only 2–3%, with the exception of Czechia, where it reached approximately 7%. This suggests that membership in the monetary union is associated with significantly stronger integration of domestic bond markets with other euro-area markets. In other words, from a volatility perspective, Slovak and Slovenian government bonds behave much more like part of a common European market. This distinction between euro-area members and non-members is one of the main findings of our study.
Romania and Hungary are also particularly interesting, as the local component dominated volatility throughout the entire period—accounting for approximately 79% in Romania and 71% in Hungary. In Romania, one possible explanation is its persistently challenging fiscal situation, characterised by so-called twin deficits—a government budget deficit and a current account deficit—as well as a less developed capital market. In Hungary, another possible explanation is the suspension of funding under the recovery plan and other EU funds, along with the resulting economic stagnation.
You examined two exceptional periods—the COVID-19 pandemic and the beginning of the war in Ukraine. Did bond markets respond differently to these two shocks?
Yes, and quite significantly. Following the outbreak of the COVID-19 pandemic, we did not observe any fundamental change in the sources of volatility. There were short-term increases in local volatility, particularly during the first weeks of the pandemic, but the situation in most countries soon began returning to pre-pandemic levels.
One possible explanation lies in the nature of the pandemic itself. It was a global shock that affected most economies simultaneously, while extensive fiscal and monetary measures were introduced very quickly, helping to stabilise financial markets. The literature on which our article builds also suggests that central bank interventions and announcements of fiscal and monetary easing were able to substantially reduce market tensions following the initial shock.
The picture was different at the beginning of Russia's invasion of Ukraine. In countries outside the euro area, the share of local volatility increased sharply—by approximately 20 percentage points in Poland and Czechia, and by around 7 percentage points in Hungary and Romania. By contrast, the structure of volatility in Slovakia and Slovenia remained largely unchanged.
How do you explain this difference? What does it tell us about the importance of geographical proximity to the war and euro-area membership?
I would start with geographical proximity. Our findings suggest that the geopolitical shock associated with the war had a stronger local effect in countries closer to the conflict. This is most evident in Poland, which also shares a border with the Russian Federation. One possible explanation for the increase in local volatility is the expectation of substantial fiscal pressures, associated, for example, with increased defence spending or measures to combat inflation. Other studies also show that geographical proximity to the conflict contributed to significant currency depreciation in the V4 countries, while the region's dependence on energy imports was another important factor.
The second part of the explanation relates to euro-area membership. As I mentioned earlier, Slovakia and Slovenia are much more closely integrated into the common European bond market and are subject to the ECB's common monetary policy. Consequently, even during the war-related shock, their bond markets continued to move more closely with the euro area, and the structure of their volatility did not change significantly. By contrast, Czechia, Poland, and Hungary have their own currencies and independent monetary policies, meaning their markets were more exposed to country-specific domestic responses to the shock.
In your article, you also argue that the results point more towards long-term financial market interdependence than towards classic financial “contagion” during crises. What is the difference between these two phenomena?
In financial literature, contagion refers to a situation in which the links between financial markets become significantly stronger following a particular shock. During a crisis, we would therefore expect volatility originating abroad to have a substantially greater influence on our markets than under normal circumstances. Interdependence, by contrast, means that these links exist over the long term and do not change fundamentally during crises.
In our results, we did not observe a significant increase in the share of global or regional volatility during either the pandemic or the period following the outbreak of the war. In fact, during the war, it was primarily the share of local volatility that increased in Poland, Czechia, and Hungary. Our findings for the period under study therefore point more towards long-term market interdependence than classic contagion.
Hypothetically, however, I would expect a different pattern during the Global Financial Crisis. Since its epicentre was located directly within the financial systems of major global economies, I would expect the share of globally transmitted volatility to have increased more substantially in our region. That would be closer to the classic definition of financial contagion. However, our data do not cover the Global Financial Crisis, so this remains a hypothesis rather than a finding of our study.
What questions remain unanswered? What would you like to explore further regarding the transmission of uncertainty between global and Central European bond markets?
We believe it is important to examine the interconnections between CEE bond markets in greater depth, as well as their relationships with other emerging markets. It would be interesting to compare the behaviour of government bond yield volatility in Central and Eastern Europe with that in regions such as Latin America or Asia, and to investigate whether opportunities for diversification or hedging exist across these markets, particularly during periods of heightened geopolitical tensions.
Another open question concerns what exactly lies behind the volatility components we have identified. In future research, we would therefore like to identify more precisely which countries transmit volatility, which macroeconomic and financial variables influence it, and what roles monetary policy, energy shocks, and geopolitical risk play.
