Evaluating sovereign risk spillovers on domestic banks during the European debt crisis

Using a Markov-switching model with time-varying probabilities, spillovers from sovereign to domestic bank CDS spreads during the European debt crisis for a set of 14 European countries and 30 European banks are investigated. Our model is able to capture how the increased sovereign risk observed between 2010 and 2013 throughout Europe has impacted i) the probability that banks fall into a crisis regime and ii) the probability that banks stay in the crisis regime. The latter state is characterized by a high volatility and large positive returns of CDS spreads. Different regime-dependent indicators have been computed to assess heterogeneity within the region. The evidence indicates that the intensification of sovereign risk observed during the European debt crisis has positively and significantly driven the regime shifts in volatility of the bank CDS spreads due to increased risk aversion. The results show that the increase in sovereign credit risk seems to have generated second-round effects for some banks that have experienced a deterioration in their funding conditions due to a rise in the domestic sovereign default risk. Overall, our results suggest that sovereign CDS spreads can be considered good forewarning indicators for predicting the evolution of bank CDS spreads. We also find that the effects differ depending on the country and the financial institution. This result suggests that banks are heterogeneously exposed to sovereign credit risk within the same country. One argument relates to the size of these financial institutions and the domestic exposure to sovereign debt.     

A note on trust in the ECB in the era of sovereign debt crisis

We employ Eurobarometer data on trust in the ECB, exploring whether trust is affected by sovereign credit rating episodes and the participation in economic adjustment programmes (EAPs) (bailout schemes). Controlling for several sociodemographic factors and macroeconomic conditions, we document a substantial negative impact on trust in ECB for countries experiencing downgrade episodes and participating in EAPs.     

Incomplete integration and contagion of debt distress in economic unions

This paper compares different fiscal integration schemes on the basis of their ability to finance public investments and resilience to debt distress and contagion. Complete integration schemes, where a central authority chooses the level of public investments with productivity‐enhancing externalities across different jurisdictions, are shown to be superior to incomplete integration schemes, where member governments choose public investments unilaterally. As a result, equilibrium income is greater for citizens of both member states under a complete integration scheme. Moreover, complete integration schemes are shown to be more resilient to idiosyncratic shocks and more effective in limiting contagion of debt distress. This is mainly because the central authority can credibly borrow more without risking default than member states taken together can and it can “transfer resilience” across them if needed. These findings inform discussions on structural aspects of secular stagnation in Europe by emphasizing a potential challenge in the institutional design of fiscal responsibilities.     

Measuring the end of the European financial crisis

In 2013 it was declared that ‘the eurozone crisis is over’. However, in fact, the series of financial crises since 2008 may have interrupted the process of EMU enlargement, which in turn triggered a continuing crisis of confidence in the euro. In this paper we extend the sigma‐convergence test to provide a more precise understanding of real interest rate parity (RIP) convergence. On the basis of this, we predict the timing for eliminating the cost of economic asymmetric shocks. Our estimation indicates the RIP among EMU members and accessions were still valid after the disruptions of the 2008 financial crisis. However, the situation has been even worse since the 2010 European sovereign debt crisis, and ceteris paribus, symmetry cannot be achieved without further policy actions. This implies that the EMU authority must do its best to strengthen symmetry and thereby solidify the EMU, at which point it will be better able to re‐start the process of enlargement.     

Sovereign bond market dependencies and crisis transmission around the eurozone debt crisis: a dynamic copula approach

We examine the dependency between the European government bond markets around the recent sovereign debt crisis. A dynamic copula approach is used to model the time-varying dependence structure of those government bond markets, evaluate the nature and strength of their dependencies over time, and gauge the transmission of the crisis shocks. Our results can be summarized as follows: i) the eurozone sovereign bond markets under consideration have a significant and positive dependence with the Greek and the EMU benchmark sovereign bond markets; ii) the dynamic-BB7 copula function best describes the dependence structure between these sovereign bond markets and provides evidence of asymmetric tail dependence; iii) the conditional probability of crisis transmission from Greece to other eurozone countries is higher than the other way around; and iv) Greece is the most vulnerable country when the eurozone entered into the sovereign debt crisis.     

Increase in home bias in the Eurozone debt crisis: The role of domestic shocks

One of the most striking consequences of the recent episode of sovereign debt market stress in the Eurozone has been the increase in the share of public debt held by the domestic sector in fragile economies. However, the causes and potential consequences of this increase were only given scarce attention in the literature on the Euro area sovereign debt crisis. In order to fill this gap, we first determine the shocks that impact the variation in the share of sovereign debt held at home in an SVAR model on a sample of Eurozone countries between 2002 and 2014, distinguishing between external and domestic shocks. Thanks to several alternative tests, we show that home bias in sovereign debt responds positively to country-specific fundamentals and expectation shocks but we find no evidence that the increase in home bias is destabilizing per se in the short-run. Second, a stylized theoretical model backed by the empirical results predicts that the consequences for sovereign debt crisis depend on the relative impact of domestic initial destabilizing shocks and increased home bias. The analysis suggests that an increase in home bias in times of sovereign debt stress, despite reflecting deteriorating fiscal conditions, may make default less likely.     

Expectations hypothesis in the context of debt crisis: Evidence from five major EU countries

The present paper examines the empirical adequacy of the expectations hypothesis of the term structure of interest rates in the context of the current debt crisis. Using a sample consisted of the five largest EU countries, namely France, Germany, Italy, Spain and the United Kingdom, and accounting for structural breaks in the data, I investigate cointegration, spread stationarity, validity of the cross-equation restrictions implied by the theory, and the possibility of excess returns. Overall, the empirical findings are against the EHTS for the whole maturity spectrum, implying evidence of economically important deviations from the theory. Only for specific spreads of France, Germany, Italy and the United Kingdom there is some evidence in favour of the expectations hypothesis.     

Business cycle affiliations in the context of European integration

We study affiliations for the countries of the European Economic and Monetary Union (EMU) with Germany and the USA, using various business cycle measures derived from quarterly real GDP. These measures are Hodrick-Prescott and Baxter-King filtered series and annual growth rates. By using rolling contemporaneous and maximum (over a short lead/lag interval) correlations, we document increasing correlations of EMU countries with Germany, with these typically being largest during the 1990s. We also document a strong leading role for the USA in relation to these countries in the period since 1993, thereby correcting the fallacy that the European business cycle was disjointed from the USA for most of the 1990s.     

The European Union's debt question: A conceptional viewpoint

The state can be conceived as an organization to protect personal freedom and to provide public goods. Consequently, we expect a constitution to consist of two different sets of rules; rules on personal freedom and rules for making collective decisions on public goods (mostly budgetary rules). The constitution of the European Union as laid down in the treaty of Maastricht (1992) provides both types of rules, but the emphasis is mainly on the former rules. This paper investigates budgetary rules, in particular the welfare economic logic of deficit spending.     

Contagion effects of the subprime crisis in the European NYSE Euronext markets

This paper presents three tests of contagion of the US subprime crisis to the European stock markets of the NYSE Euronext group. Copula models are used to analyse dependence structures between the US and the other stock markets in the sample, in the pre-crisis and in the subprime crisis periods. The first test assesses the existence of contagion on the relevant stock markets’ indices, the second checks the homogeneity of contagion intensities, and the third compares contagion in financial and in industrial sectors’ indices. Results suggest that contagion exists, and is equally felt, in most stock markets and that investors anticipated a spreading of the financial crisis to the indices of industrial sectors, long before such dissemination was observable in the real economy.     

Household debt and spending during the financial crisis: Evidence from Danish micro data

We use data for nearly 500,000 Danish households to study the relationship between household leverage prior to the financial crisis of 2007–2009 and the development in spending over the course of the crisis. We find a strong negative correlation between pre-crisis leverage and the change in spending during the crisis. This reflects that highly levered households spent a larger share of their income than their less-levered peers prior to the crisis, resulting in larger increases in debt in these years. Once we condition on the size of the pre-crisis change in debt, a high level of debt is no longer associated with a larger spending decline. Our results suggest that the larger decline in spending among high-leverage households is the result of a spending normalization pattern that is also found in other years, rather than a causal effect of high debt levels suppressing household spending during the crisis.     

Compression in monetary user costs in the aftermath of the financial crisis: implications for the Divisia M4 monetary aggregate

Differences in Divisia and simple-sum money arise from appropriate weighing mechanisms in Divisia, which rely on information on the user cost of monetary assets. We show convergence in the growth rate of Divisia M4 and its simple-sum counterpart beginning in early 2009, shortly after the collapse in the Federal Funds rate. This phenomenon results from compression in user costs.     

Causes and hazards of the euro area sovereign debt crisis: Pure and fundamentals-based contagion

This paper tries to contribute to the understanding of sovereign debt crises' pattern by empirically investigating the determinants of the recent euro area crisis to assess if its transmission was due to “pure” or “fundamentals-based” contagion. Using sovereign bond yield spreads with respect to Germany for a sample of ten central and peripheral countries from January 1999 to December 2012, we firstly examine the dynamic evolution of Granger-causality within the 90 pairs of yield spreads in our sample to detect episodes of contagion (associated with episodes of significant intensification in causality). Secondly, we make use of a logit model to explore whether there is evidence of “pure contagion” or “fundamentals-based contagion”, by trying to determine which factors might have been behind the detected contagion episodes. Our results suggest that contagion episodes are concentrated just after the inception of the EMU and matching the Global Financial Crisis, yielding more accurate and sensible indicators than those obtained from DCC-GARCH models used in prior studies. Indeed, they preceded the outburst of the Global Financial Crisis (causality intensification is detected from March 2008), and reached a peak during January–May 2011. Furthermore, they underline the coexistence of “pure” and “fundamentals-based contagion” during the recent European debt crisis.     

The European refugee crisis and the natural rate of output

The European Commission follows a harmonized approach for calculating structural (potential) output for EU member states that takes into account labour as an important ingredient. This article shows how the recent huge migrants’ inflow to Europe affects trend output. Due to the fact that the immigrants immediately increase the working population but effectively do not enter the labour market, we illustrate that the potential output is potentially upward biased without any corrections. Taking Germany as an example, we find that the average medium-term potential growth rate is lower if the migration flow is modelled adequately compared to results based on the unadjusted European Commission procedure.     

Monetary integration,soft budget constraints,and the EMU sovereign debt crises

One possible explanation for the European sovereign debt crises is that the European Economic and Monetary Union (EMU) gave rise to consolidation fatigue or even deliberate over‐borrowing. This paper explores the validity of this explanation by studying how three decisive stages in the history of the EMU affected public borrowing in EU member states: the signing of the Maastricht Treaty, the introduction of the Euro, and the suspension of the Stability and Growth Pact (SGP). The methodology relies on difference‐in‐difference regressions for 26 OECD countries over the 1975–2009 period. The findings indicate that the Maastricht treaty reduced deficits especially in traditionally high‐deficit countries. In contrast, the introduction of the Euro and the watering down of the original SGP led on average to higher borrowing. These results indicate that the introduction of the Euro and the suspension of the SGP led to soft budget constraints in the EMU.     

European financial crisis and bank productivity: evidence from Eastern European Countries

The paper examines the productivity levels of the largest banks operating in the Eastern European countries over the period of the ongoing European financial crisis. Specifically, the analysis covers the periods of U.S. subprime crisis, the global financial crisis and the sovereign debt crisis. By adopting a fully nonparametric framework, it provides a probabilistic version of a directional input-oriented Malmquist productivity index alongside with its main decomposition. The results from the analysis suggest that banks have faced a deterioration of their productivity levels between the examined periods. It is evident that during the initiation of European sovereign debt crisis, the banks have weakened their ability to utilize efficiently their inputs of production and their ability to realize scale economies.     

The eurozone financial crisis: debt,credit ratings and monetary and fiscal policy

This paper discusses the eurozone financial crisis. It argues that it was largely the result of a common monetary policy not being suitable for individual countries which led to excessive private and public borrowing and a debt crisis. Neither borrowing rates nor credit ratings anticipated the crisis. Fundamental changes to eurozone governance are being proposed. The paper examines whether instead there might be a market solution if financial markets priced risk better. Accordingly, a more timely way of obtaining credit ratings is shown.     

Transmission channels of international financial crises to African stock markets: the case of the euro sovereign debt crisis

This article investigates the effects of the European sovereign debt crisis on African stock markets within a Bayesian shrinkage VAR framework. This method allows us to consider both North African and Sub-Saharan African stock markets, and provides a flexible parsimonious specification. The results reveal varying reactions of the impulse response functions. The most exposed African stock markets are those of Egypt, South Africa and Mauritius, while the least affected stock market is, surprisingly, that of Ivory Coast. Our analysis shows that, in addition to direct transmission, several macroeconomic and market channels, such as commodities, exports, and exchange rates, are relevant. Specifically, countries with strong commercial links to European countries will be most impacted by the crisis. The severity of transmission also depends on the country’s dependence on commodities.