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Transmission of sovereign risk in the Euro crisis

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  • Brutti, Filippo
  • Sauré, Philip

Abstract

We assess the role of financial linkages for the transmission of sovereign risk in the Euro crisis. Building on the narrative approach by Romer and Romer (1989, 2010) and augmented by Mertens and Ravn (2013), we use financial news to identify structural shocks in a vector autoregressive model of daily sovereign CDS premia for eleven European countries. To estimate how these shocks transmit across borders, we use data on cross-country bank exposures to sovereign debt. Our results indicate that cross-border financial exposures constitute important transmission channels: a reduction of exposure to overall Greek debt by one standard deviation is associated with a reduction in the response of the sovereign CDS to a shock to Greek sovereign risk by about three quarter in the average country. Decomposing these effects, we find that exposures to sovereign debt constitute significant transmission channels, while we find no robust support for transmission through bank-to-bank lending.

Suggested Citation

  • Brutti, Filippo & Sauré, Philip, 2015. "Transmission of sovereign risk in the Euro crisis," Journal of International Economics, Elsevier, vol. 97(2), pages 231-248.
  • Handle: RePEc:eee:inecon:v:97:y:2015:i:2:p:231-248
    DOI: 10.1016/j.jinteco.2015.03.009
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    Cited by:

    1. Fernando Broner & Daragh Clancy & Alberto Martin & Aitor Erce, 2017. "Fiscal multipliers and foreign holdings of public debt," Economics Working Papers 1610, Department of Economics and Business, Universitat Pompeu Fabra, revised Jul 2018.
    2. Patrick Augustin, 2012. "Sovereign Credit Default Swap Premia," Working Papers 12-10, New York University, Leonard N. Stern School of Business, Department of Economics.
    3. Gorea, Denis & Radev, Deyan, 2014. "The euro area sovereign debt crisis: Can contagion spread from the periphery to the core?," International Review of Economics & Finance, Elsevier, vol. 30(C), pages 78-100.
    4. Beetsma, Roel & de Jong, Frank & Giuliodori, Massimo & Hanson, Jesper, 2016. "Domestic and Cross-Border Auction Cycle Effects of Sovereign Bond Issuance in the Euro Area," CEPR Discussion Papers 11122, C.E.P.R. Discussion Papers.
    5. Augustin, Patrick & Subrahmanyam, Marti G. & Tang, Dragon Yongjun & Wang, Sarah Qian, 2014. "Credit Default Swaps: A Survey," Foundations and Trends(R) in Finance, now publishers, vol. 9(1-2), pages 1-196, December.
    6. Holtemöller, Oliver & Scherer, Jan-Christopher, 2018. "Sovereign stress, banking stress, and the monetary transmission mechanism in the Euro area," IWH Discussion Papers 3/2018, Halle Institute for Economic Research (IWH).
    7. Patrick Augustin & Hamid Boustanifar & Johannes Breckenfelder & Jan Schnitzler, 2018. "Sovereign to Corporate Risk Spillovers," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 50(5), pages 857-891, August.
    8. Caporin, Massimiliano & Pelizzon, Loriana & Ravazzolo, Francesco & Rigobon, Roberto, 2018. "Measuring sovereign contagion in Europe," Journal of Financial Stability, Elsevier, vol. 34(C), pages 150-181.
    9. repec:eee:intfin:v:52:y:2018:i:c:p:17-36 is not listed on IDEAS
    10. Kobielarz, Michal, 2018. "The economics of monetary unions," Other publications TiSEM b0293536-68ec-4905-bffd-6, Tilburg University, School of Economics and Management.
    11. repec:eee:inecon:v:113:y:2018:i:c:p:1-19 is not listed on IDEAS
    12. Illenin Kondo & Fabrizio Perri & Sewon Hur, 2016. "Inflation, Debt, and Default," 2016 Meeting Papers 1610, Society for Economic Dynamics.
    13. Wolfinger, Julia & Köhler, Ekkehard, 2017. "The Draghi-Put: When unexpected words on joint liability speak louder than actions," Annual Conference 2017 (Vienna): Alternative Structures for Money and Banking 168265, Verein für Socialpolitik / German Economic Association.
    14. Wu, Eliza & Erdem, Magdalena & Kalotychou, Elena & Remolona, Eli, 2016. "The anatomy of sovereign risk contagion," Journal of International Money and Finance, Elsevier, vol. 69(C), pages 264-286.
    15. Pagano, Michael S. & Sedunov, John, 2016. "A comprehensive approach to measuring the relation between systemic risk exposure and sovereign debt," Journal of Financial Stability, Elsevier, vol. 23(C), pages 62-78.
    16. Papafilis, Michalis-Panayiotis & Psillaki, Maria & Margaritis, Dimitris, 2015. "Interdependence between Sovereign and Bank CDS Spreads in Eurozone during the European Debt Crisis - The PSI Effect," MPRA Paper 68037, University Library of Munich, Germany.
    17. Matthew Greenwood-Nimmo & Viet Hoang Nguyen & Yongcheol Shin, 2017. "What’s Mine Is Yours: Sovereign Risk Transmission during the European Debt Crisis," Melbourne Institute Working Paper Series wp2017n17, Melbourne Institute of Applied Economic and Social Research, The University of Melbourne.
    18. repec:eee:reveco:v:54:y:2018:i:c:p:123-142 is not listed on IDEAS

    More about this item

    Keywords

    Cross-country transmission; Sovereign risk; Financial linkages; Euro crisis narrative approach;

    JEL classification:

    • F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration
    • F42 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Policy Coordination and Transmission
    • F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements
    • C30 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - General

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