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Self-fulfilling crises in the Eurozone: An empirical test

Listed author(s):
  • De Grauwe, Paul
  • Ji, Yuemei

We test the hypothesis that the government bond markets in the Eurozone are more fragile and more susceptible to self-fulfilling liquidity crises than in stand-alone countries. We find evidence that a significant part of the surge in the spreads of the peripheral Eurozone countries during 2010–11 was disconnected from underlying increases in the debt to GDP ratios and fiscal space variables, and was associated with negative self-fulfilling market sentiments that became very strong since the end of 2010. We argue that this can drive member countries of the Eurozone into bad equilibria. We also find evidence that after years of neglecting high government debt, investors became increasingly worried about this in the Eurozone, and reacted by raising the spreads. No such worries developed in stand-alone countries despite the fact that debt to GDP ratios and fiscal space variables were equally high and increasing in these countries.

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File URL: http://www.sciencedirect.com/science/article/pii/S0261560612001829
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Article provided by Elsevier in its journal Journal of International Money and Finance.

Volume (Year): 34 (2013)
Issue (Month): C ()
Pages: 15-36

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Handle: RePEc:eee:jimfin:v:34:y:2013:i:c:p:15-36
DOI: 10.1016/j.jimonfin.2012.11.003
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/30443

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  1. Guglielmo Maria Caporale & Alessandro Girardi, 2011. "Fiscal Spillovers in the Euro Area," Discussion Papers of DIW Berlin 1164, DIW Berlin, German Institute for Economic Research.
  2. Arghyrou, Michael G. & Kontonikas, Alexandros, 2011. "The EMU sovereign-debt crisis: fundamentals, expectations and contagion," SIRE Focus Papers 2011-01, Scottish Institute for Research in Economics (SIRE).
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  7. Obstfeld, Maurice, 1986. "Rational and Self-fulfilling Balance-of-Payments Crises," American Economic Review, American Economic Association, vol. 76(1), pages 72-81, March.
  8. Schuknecht, Ludger & von Hagen, Jürgen & Wolswijk, Guido, 2010. "Government bond risk premiums in the EU revisited: the impact of the financial crisis," Working Paper Series 1152, European Central Bank.
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  13. Boehmer, Ekkehart & Megginson, William L, 1990. " Determinants of Secondary Market Prices for Developing Country Syndicated Loans," Journal of Finance, American Finance Association, vol. 45(5), pages 1517-1540, December.
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  15. Edwards, Sebastian, 1986. "The pricing of bonds and bank loans in international markets : An empirical analysis of developing countries' foreign borrowing," European Economic Review, Elsevier, vol. 30(3), pages 565-589, June.
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  17. De Grauwe, Paul, 2011. "Governance of a Fragile Eurozone," CEPS Papers 5523, Centre for European Policy Studies.
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