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Contagion in the EMU – The Role of Eurobonds with OMTs


  • Favero Carlo A.

    () (Deutsche Bank Chair in Asset Pricing and Quantitative Finance, Department of Finance, Bocconi University, IGIER and CEPR, Milano, Italy)

  • Missale Alessandro

    () (Department of Economics, Management and Quantitative Methods (DEMM), Università degli Studi di Milano, Milano, Italy)


We find strong evidence of country interdependence in the pricing of default risk, which suggests that a crisis can easily propagate from countries with weak fiscal fundamentals to other fiscally sounder member States. Interest rate interdependence differs between countries with high interest rates – high yielders – and countries with low interest rates – low yielders –. The former countries are linked through global spreads; i. e. they are exposed to the interest rate spreads (over Germany) of other troubled countries to a degree which increases with fiscal proximity. Low yielders with sounder fiscal fundamentals are partially immune from the high interest rates of fiscally weak member States but are still exposed to the risk of a euro break-up that is priced in Quanto CDS. This “euro risk” factor is a main driver of the interest rate spreads of low yielders until August 2012. More importantly, our case study of Italy shows that the impact of the global spread variable is dominated by changes in market sentiment, a sign that the Italian 2011–2012 crisis had the characteristics of a debt run more than a crisis of fundamentals. This evidence suggests that Eurobonds would be justified as an instrument for crisis prevention in the absence of a “lender of last resort”. With the announcement of OMTs, the ECB seems to have taken such role upon itself, mainly as a response to the risk of a euro break-up. We show that OMTs led to a significant fall in the impact effect of the global spread variable in the Italian case. The ECB’s ability to buy member States’ bonds reduces the risk of a self-fulfilling debt run but also deprives Eurobonds of their role in crisis prevention. Proposals to introduce Eurobonds to finance investment projects and expenditures related to the security and refugee crisis appear more realistic.

Suggested Citation

  • Favero Carlo A. & Missale Alessandro, 2016. "Contagion in the EMU – The Role of Eurobonds with OMTs," Review of Law & Economics, De Gruyter, vol. 12(3), pages 555-584, November.
  • Handle: RePEc:bpj:rlecon:v:12:y:2016:i:3:p:555-584:n:5

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    References listed on IDEAS

    1. Pesaran M.H. & Schuermann T. & Weiner S.M., 2004. "Modeling Regional Interdependencies Using a Global Error-Correcting Macroeconometric Model," Journal of Business & Economic Statistics, American Statistical Association, vol. 22, pages 129-162, April.
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    More about this item


    Eurobonds; global VAR; bond spreads in the euro-area; default premium; liquidity premium; Euro break-up; ESM; OMTs;

    JEL classification:

    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics


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