We use a Smooth Transition Conditional Correlation GARCH (STCC-GARCH) model applied to the euro area monetary policy rates and sovereign yields of Italy, Spain and Germany at 5-year maturity to estimate the threshold level of the signals above which the sovereign bond market moves to a crisis regime. We show that the threshold to a crisis regime for Italy and Spain is reached when (i) their 5-year sovereign yield spreads amount to about 90 basis points; (ii) their 5-year CDS spreads amount to about 155 basis points or (iii) the 5-year spread between the Kreditanstalt für Wiederaufbau (KfW) bond and the German Bund amounts to about 30–40 basis points. Using impulse responses, we find that the STCC-GARCH with the KfW-Bund spread has leading properties, a feature corroborated by the fact that this indicator suggested a shift to a crisis regime already in August 2007 and has been signaling an improvement of the situation already in the autumn of 2012. An out-of-sample forecast of the STCC-GARCH model is also provided, which is both a novelty and a further robustness check for the stability of the model.

I extract a latent systematic risk factor, which is orthogonal to idiosyncratic risk and observable systematic risk, from credit spreads for 1764 Eurobonds across euro area non-financial firms over the 1999–2015 period. The extracted common latent factor negatively predicts stock market excess returns, the growth rate in real economic activity and economic sentiment. It predicts the financial crisis and the two economic recessions.