Sovereign Financial Asset Market Linkages across Europe During the Euro Zone Debt Crisis

We estimate a GVAR model of the European Union (EU) sovereign bond spreads and Credit Default Swap (CDS) differentials with respect to their German counterparts, based on monthly observations from November 2009 to March 2015. We capture time- varying interdependence among variables by computing annual weight matrices based on “macro distances” between countries. This measure of distance is similar to the “fiscal distance” recently used in literature, but more comprehensive. The model is augmented with a Dominant Unit, comprising a number of three market-based global variables. Aggregating the country variables into four regions (Eurocore, Europeriphery, non-euro CEE countries and Non-euro Developed countries), we perform a dynamic analysis to investigate: the propagation of shocks coming from Greece or from Europeriphery to the EU sovereign markets; the behavior of the two non-euro regions sovereigns; the main channels of contagion across each region; the interactions between the EU sovereign markets and the global risk sentiment; the spillover effects of the latest policy actions of the ECB outside the Euro Zone.