It is normal for a rise in risk-free interest rates to drive up risk premia: The case of euro-zone sovereign bonds

Normally, a rise in risk-free interest rates leads to a rise in risk premia, as investors are encouraged to return from risky financial assets to risk-free financial assets (government bonds) whose yields have become attractive again. One would therefore expect the rise in risk-free interest rates in the euro zone (Germany’s long-term interest rate) to lead to a rise in the peripheral countries’ yield spreads against Germany. This was seen in 2008, 2010 and 2017-2018. It is also the current configuration (2021-2022). But this was not the case during the euro-zone crisis (2010-2014), when peripheral spreads widened as Germany’s long-term interest rate fell. This resulted from the fact that the source of the risk during the euro-zone crisis was in the peripheral countries: the shift to risk-free bonds at the time was due to risk aversion, not a rise in risk-free yields.