The impact of central bank backstops on sovereign risk premia: Evidence from the ECB's Transmission Protection Instrument

Abstract

We study the effects of central bank backstops on sovereign risk premia using the Eurosystem’s Transmission Protection Instrument (TPI) announced in July 2022. We develop a nonlinear non-Gaussian state-space model that decomposes euro area sovereign yields into expected short rates, a common term premium, and country-specific default, redenomination, liquidity, and convenience premia. Structural shocks are identified through fat tails and heteroscedasticity. Using euro area data from 2015 to 2025, we extract latent risk premia and assess the impact of the TPI using event-time and differences-in-differences designs. The results show that the TPI primarily increased the convenience value of sovereign bonds and reduced the volatility of a subset of shocks, while leaving other risk premia largely unchanged. Lower convenience-adjusted yields partially dampened the transmission of policy rate hikes to medium-term sovereign yields. Joint paper with Maria A. Viola.