The Contagion of the Greek Fiscal Crisis and Structural Changes in the Euro Sovereign Bond Markets

This article analyzes recent developments in the euro sovereign bond markets where the successive contagion of financial crisis has unfolded, with particular focus upon crisis contagion and structural changes in the market. We take up the following four issues. First, we regard two junctures-one being the new Greek government's announcement of the upward revision of their fiscal deficit, triggering market frenzies, and the other being the agreement upon 750 billion euros in financial assistance-as major turning points and examine whether structural changes occurred in the markets on these two occasions. Second, instead of pre-specifying the change points, we examine the differences in the timings of structural change in the countries, assuming those timings are in fact unknown. Third, we prove by using the Dynamic Conditional Correlation Multivariate-GARCH (DCC M-GARCH) model that the correlation among the euro sovereign bond yields lowered notably after the Greek crisis broke out. Fourth, we examine the propagation of hiked bond yields and increased volatility from crisis-ridden Greece, Portugal, and Ireland to other countries by applying tests on causality-in-mean and causality-in-variance. We draw the following four conclusions. First, the hypothesis that all the European countries went through structural changes at the aforementioned two points is not statistically supported, which suggests that even in the single currency zone the timing of structural change may differ depending upon each country's economic situation. Second, assuming that the timing of structural change is unknown, we confirm that the European government bond markets went through various shocks from 2007 onwards, resulting in intermittent changes in the parameters in the yield model. Third, we confirm that in the period leading up to the downturn after the collapse of the Lehman Brothers (hereinafter referred to as the "Lehman Shock"), the correlation between the German sovereign bond yields and those of the other euro countries was generally high, but after the Lehman Shock, the correlation with the German bonds gradually lowered in the case of the bond yields of Greece, Ireland, Portugal, and Italy. This result implies that no single event was a turning point for the correlations among the euro zone countries but that the timings of the turning points differed country by country. Fourth, the results of the causality-in-mean and causality-in-variance tests indicate that while the former tends to be detected in the early stages, the latter appears only later. We confirm from the results of these causality tests that there was contagion of the Greek shock to the major euro countries such as Spain, Italy, France, and Germany.