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I am trying to better understand the sovereign bond market in the eurozone. In particular is it costlier for some institutions to hold periphery country bonds that contain more credit risk than say German bonds?

The funding cost for periphery country bonds can be higher due to higher repo haircuts. However, I have understood that all these bonds have zero risk weight when measuring capital adequacy, suggesting they have similar balance sheet cost for banks.

Is there some other reason why it might be more expensive to hold periphery country bonds? Such costs could help explain the behavior of eurozone sovereign bond yields and the occasionally large CDS bond basis of periphery country bonds.

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  • $\begingroup$ Isn’t it simply that periphery countries are more likely to default than core countries ? $\endgroup$
    – dm63
    Dec 25, 2021 at 15:59
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    $\begingroup$ @dm63 Yes credit risk is likely the biggest reason why costs are higher (possibly also illiquidity). But are the costs only higher due to repo haircuts (and not e.g. capital requirements) or is there something else? $\endgroup$
    – fesman
    Dec 25, 2021 at 16:21
  • $\begingroup$ @dm63 Also note that periphery country bonds tend to trade at a negative CDS basis: Italian bond + Italian CDS is cheaper than a German bond. $\endgroup$
    – fesman
    Dec 25, 2021 at 16:25
  • $\begingroup$ Ok good point about the basis. I know that what you say about repo haircuts and liquidity is definitely true and could suffice as an explanation. Let’s see if anyone has other ideas. $\endgroup$
    – dm63
    Dec 26, 2021 at 0:17

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