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Banking and sovereign risk in the euro area

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  • Gerlach, Stefan
  • Schulz, Alexander
  • Wolff, Guntram B.

Abstract

We study the determinants of sovereign bond spreads in the euro area since the introduction of the euro. We show that an aggregate risk factor is a main driver of spreads. This factor also plays an important indirect role for risk spreads through its interaction with the size and structure of national banking sectors. When aggregate risk increases, countries with large banking sectors and low equity ratios in the banking sector experience greater widening in yield spreads, suggesting that financial markets perceive a larger risk that governments will have to rescue banks, increasing public debt and therefore sovereign risk. Moreover, government debt levels and forecasts of future fiscal deficits are also significant determinants of sovereign spreads. --

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Bibliographic Info

Paper provided by Deutsche Bundesbank, Research Centre in its series Discussion Paper Series 1: Economic Studies with number 2010,09.

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Date of creation: 2010
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Handle: RePEc:zbw:bubdp1:201009

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Keywords: Sovereign bond markets; banking; liquidity; EMU;

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  1. Kerstin Bernoth & Guntram B. Wolff, 2006. "Fool the Markets? Creative Accounting, Fiscal Transparency and Sovereign Risk Premia," CESifo Working Paper Series 1732, CESifo Group Munich.
  2. Peter G. Dunne & Michael J. Moore & Richard Portes, 2007. "Benchmark Status in Fixed-Income Asset Markets," Journal of Business Finance & Accounting, Wiley Blackwell, Wiley Blackwell, vol. 34(9-10), pages 1615-1634.
  3. Dimitri Vayanos & Pierre-Olivier Weill, 2007. "A search-based theory of the on-the-run phenomenon," LSE Research Online Documents on Economics, London School of Economics and Political Science, LSE Library 24474, London School of Economics and Political Science, LSE Library.
  4. Schuknecht, Ludger & von Hagen, Jürgen & Wolswijk, Guido, 2009. "Government risk premiums in the bond market: EMU and Canada," European Journal of Political Economy, Elsevier, vol. 25(3), pages 371-384, September.
  5. Bernoth, Kerstin & von Hagen, Jürgen & Schuknecht, Ludger, 2004. "Sovereign risk premia in the European government bond market," Working Paper Series, European Central Bank 0369, European Central Bank.
  6. Hallerberg, Mark & Strauch, Rolf & von Hagen, Jurgen, 2007. "The design of fiscal rules and forms of governance in European Union countries," European Journal of Political Economy, Elsevier, vol. 23(2), pages 338-359, June.
  7. von Hagen, Jürgen & Wolff, Guntram, 2004. "What Do Deficits Tell us About Debts? Empirical Evidence on Creative Accounting with Fiscal Rules in the EU," CEPR Discussion Papers, C.E.P.R. Discussion Papers 4759, C.E.P.R. Discussion Papers.
  8. Simone Manganelli & Guido Wolswijk, 2009. "What drives spreads in the euro area government bond market?," Economic Policy, CEPR;CES;MSH, CEPR;CES;MSH, vol. 24, pages 191-240, 04.
  9. Buraschi, Andrea & Menini, Davide, 2002. "Liquidity risk and specialness," Journal of Financial Economics, Elsevier, Elsevier, vol. 64(2), pages 243-284, May.
  10. Pesaran, M. Hashem & Smith, Ron, 1995. "Estimating long-run relationships from dynamic heterogeneous panels," Journal of Econometrics, Elsevier, Elsevier, vol. 68(1), pages 79-113, July.
  11. Vincent Koen & Paul van den Noord, 2005. "Fiscal Gimmickry in Europe: One-Off Measures and Creative Accounting," OECD Economics Department Working Papers 417, OECD Publishing.
  12. Alois Geyer & Stephan Kossmeier & Stefan Pichler, 2004. "Measuring Systematic Risk in EMU Government Yield Spreads," Review of Finance, Springer, Springer, vol. 8(2), pages 171-197.
  13. Lorenzo Codogno & Carlo Favero & Alessandro Missale, 2003. "Yield spreads on EMU government bonds," Economic Policy, CEPR;CES;MSH, CEPR;CES;MSH, vol. 18(37), pages 503-532, October.
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