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Systemic Risk and Home Bias in the Euro Area


  • Niccolò Battistini
  • Marco Pagano
  • Saverio Simonelli


According to conventional indicators, the euro-area financial integration has receded since 2007, mainly in the money market, sovereign debt market and uncollateralized credit markets. But price-based measures of debt market segmentation are inappropriate when solvency risk differs across countries: only the component of yield differentials that is not a reward for the issuer’s credit risk may reflect segmentation. We apply this idea to the euro sovereign debt market, using a dynamic factor model to decompose yield differentials in a country-specific and a common (or systemic) risk component. As the country-specific component dominates, purging yields from it produces much smaller measures of bond market segmentation than conventional ones for the crisis period. We also investigate how the home bias of banks’ sovereign portfolios – a quantity-based measure of segmentation – is related to yield differentials, by estimating a vector error-correction model on 2008-12 monthly data. We find that the sovereign exposures of banks in most euro-area countries respond positively to increases in yields, especially in periphery countries. When yield differentials are decomposed in their country-risk and common-risk components, we find that: (i) in the periphery, banks respond to increases in country risk by increasing their domestic exposure, while in core countries they do not; (ii) in contrast, in most euro-area countries banks respond to an increase in the common risk factor by raising their domestic exposures. Finding (i) hints at distorted incentives in periphery banks’ response to changes in their own sovereign’s risk. Finding (ii) indicates that, when systemic risk increases, all banks tend to increase the home bias of their portfolios, making the euro-area sovereign market more segmented.

Suggested Citation

  • Niccolò Battistini & Marco Pagano & Saverio Simonelli, 2013. "Systemic Risk and Home Bias in the Euro Area," European Economy - Economic Papers 2008 - 2015 494, Directorate General Economic and Financial Affairs (DG ECFIN), European Commission.
  • Handle: RePEc:euf:ecopap:0494

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    References listed on IDEAS

    1. Hans-Werner Sinn & Timo Wollmershäuser, 2012. "Target loans, current account balances and capital flows: the ECB’s rescue facility," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 19(4), pages 468-508, August.
    2. Carmen M. Reinhart & Kenneth S. Rogoff, 2009. "Varieties of Crises and Their Dates," Introductory Chapters,in: This Time Is Different: Eight Centuries of Financial Folly Princeton University Press.
    3. Mayer, Thomas & Gros, Daniel, 2011. "Debt reduction without default?," CEPS Papers 4150, Centre for European Policy Studies.
    4. Romain Bouis & Romain Duval, 2011. "Raising Potential Growth After the Crisis: A Quantitative Assessment of the Potential Gains from Various Structural Reforms in the OECD Area and Beyond," OECD Economics Department Working Papers 835, OECD Publishing.
    5. Silvia Merler & Jean Pisani-Ferry, 2012. "Sudden Stops in the Euro Area," Review of Economics and Institutions, Università di Perugia, vol. 3(3).
    6. Reinhart, Karmen & Rogoff, Kenneth, 2009. ""This time is different": panorama of eight centuries of financial crises," Economic Policy, Russian Presidential Academy of National Economy and Public Administration, vol. 1, pages 77-114, March.
    7. Giavazzi, Francesco & Spaventa, Luigi, 2010. "Why the current account may matter in a monetary union: Lessons from the financial crisis in the Euro area," CEPR Discussion Papers 8008, C.E.P.R. Discussion Papers.
    8. Bergljot B Barkbu & Jesmin Rahman & Rodrigo O. Valdes, 2012. "Fostering Growth in Europe Now," IMF Staff Discussion Notes 12/07, International Monetary Fund.
    9. Daniel Gros & Cinzia Alcidi, 2011. "euro zone crisis 2010," The New Palgrave Dictionary of Economics, Palgrave Macmillan.
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    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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