We propose an easy to implement yield curve extrapolation method to determine long-term interest rates suitable for regulatory valuation. We empirically evaluate this approach for the German nominal bond market, by estimating the model on bonds with maturities up to 20 years and assessing the out-of-sample performance for bonds with maturities beyond 20 years. Even though observed long-term yields are somewhat lower than the predicted yields, the method performs quite well empirically given its simplicity. We perform a case study on pension fund liability valuation and show that our proposed method would have a substantial impact on liability values.

This study investigates herd behavior exhibited by pension funds in the sovereign bond market before, during and after the European debt crisis. It uses unique monthly data on sovereign bond holdings of pension funds and transactions between December 2008 and December 2014. The dataset covers 67 large Dutch pension funds that invest in bonds from 109 countries. We find evidence of intensive herd behavior of Dutch pension funds in sovereign bonds. We also distinguish between European countries which suffer from the European debt crisis, such as Cyprus, Greece, Ireland, Italy, Portugal and Spain, and those that have not. We find high sell herding and low buy herding for the crisis countries during the European debt crisis, whereas in the non-crisis period their herd behavior does not differ substantially from that in non-crisis countries. When we control for institutional, macroeconomic, financial market and pension fund factors, sell herding in crisis countries is still significantly higher. However, we find no evidence of destabilizing behavior with respect to bonds of crisis countries during the European debt crisis.

We examine the effect of sovereign credit default swaps (CDS) trading initiation on the occurrence of sovereign debt crises (SDC). Estimations on a large sample of 141 countries for 1980–2013 reveal that, by affecting the fiscal stance, CDS initiation increases by around 1.5 percentage points on average the probability of SDC in countries with CDS compared to the other countries. This result holds for different robustness tests and is found to be stronger for developing countries, for countries with initial lower creditworthiness, and when the degrees of central bank independence and public sector transparency are low. Consequently, compared to existing work emphasizing favorable effects, CDS trading initiation is found to have adverse effects, by increasing the occurrence of SDC. These opposite effects should fuel the literature on measuring the consequences of CDS trading initiation, and its design and implementation from a policy perspective.