IDEAS home Printed from https://ideas.repec.org/a/bpj/rlecon/v12y2016i3p555-584n5.html
   My bibliography  Save this article

Contagion in the EMU – The Role of Eurobonds with OMTs

Author

Listed:
  • 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)

Abstract

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
    as

    Download full text from publisher

    File URL: https://www.degruyter.com/view/j/rle.2016.12.issue-3/rle-2016-0043/rle-2016-0043.xml?format=INT
    Download Restriction: For access to full text, subscription to the journal or payment for the individual article is required.

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    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.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    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

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:bpj:rlecon:v:12:y:2016:i:3:p:555-584:n:5. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Peter Golla). General contact details of provider: https://www.degruyter.com .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.