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Is the European sovereign crisis self-fulfilling ? Empirical evidence about the drivers of market sentiments

  • Catherine Bruneau

    (Université Paris I)

  • Anne-Laure Delatte

    (Rouen Business School)

  • Julien Fouquau

    (Rouen Business School)

We assess the nature of the European sovereign crisis in the light of a model borrowed from the second generation of currency crises. We bring the theory to the data to empirically test the presence of self-fulfilling dynamics and to identify what may have driven the market sentiment during this crisis. To do so we estimate the probability of default of five European ”peripheral” countries during January 2006 to September 2011 with a panel smooth threshold regression. Our estimation results suggest that 1/ both the fundamentals and ”animal spirit” ignited the European sovereign crisis; 2/ the sovereign Credit Defa ult Swap market (CDS), the rating agencies and the CDS of the banking sector have played dominant roles in driving market sentiments.

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Paper provided by Observatoire Francais des Conjonctures Economiques (OFCE) in its series Documents de Travail de l'OFCE with number 2012-22.

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Date of creation: Sep 2012
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Handle: RePEc:fce:doctra:1222
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  1. Aizenman, Joshua & Hutchison, Michael & Jinjarak, Yothin, 2011. "What is the Risk of European Sovereign Debt Defaults? Fiscal Space, CDS Spreads and Market Pricing of Risk," Santa Cruz Department of Economics, Working Paper Series qt2914v9fh, Department of Economics, UC Santa Cruz.
  2. Borgy, V. & Laubach, T. & Mésonnier, J-S. & Renne, J-P., 2011. "Fiscal Sustainability, Default Risk and Euro Area Sovereign Bond Spreads Markets," Working papers 350, Banque de France.
  3. Jeanne, Olivier, 1997. "Are currency crises self-fulfilling?: A test," Journal of International Economics, Elsevier, vol. 43(3-4), pages 263-286, November.
  4. Jeanne, Olivier & Masson, Paul, 2000. "Currency crises, sunspots and Markov-switching regimes," Journal of International Economics, Elsevier, vol. 50(2), pages 327-350, April.
  5. Delatte, Anne-Laure & Gex, Mathieu & López-Villavicencio, Antonia, 2012. "Has the CDS market influenced the borrowing cost of European countries during the sovereign crisis?," Journal of International Money and Finance, Elsevier, vol. 31(3), pages 481-497.
  6. Harold L. Cole & Timothy J. Kehoe, 1998. "Self-Fulfilling Debt Crises," Levine's Working Paper Archive 114, David K. Levine.
  7. González, Andrés & Teräsvirta, Timo & van Dijk, Dick, 2005. "Panel Smooth Transition Regression Models," SSE/EFI Working Paper Series in Economics and Finance 604, Stockholm School of Economics.
  8. Corsetti, G. & Cavallari, L., 1996. "Policy Making and Speculative Attacks in Models of Exchange Rate Crises: A Synthesis," Papers 752, Yale - Economic Growth Center.
  9. Julien FOUQUAU & Christophe HURLIN & Isabelle RABAUD, 2006. "The Feldstein-Horioka Puzzle : a Panel Smooth Transition Regression Approach," Working Papers 1610, Orleans Economic Laboratorys, University of Orleans.
  10. Robert P. Flood & Nancy P. Marion, 1996. "Speculative Attacks: Fundamentals and Self-Fulfilling Prophecies," NBER Working Papers 5789, National Bureau of Economic Research, Inc.
  11. Paul De Grauwe, 2010. "The Financial Crisis and the Future of the Eurozone," Bruges European Economic Policy Briefings 21, European Economic Studies Department, College of Europe.
  12. Afonso, António & Gomes, Pedro & Rother, Philipp, 2007. "What “hides” behind sovereign debt ratings?," Working Paper Series 0711, European Central Bank.
  13. Carmen M. Reinhart & Kenneth S. Rogoff, 2009. "This Time Is Different: Eight Centuries of Financial Folly," Economics Books, Princeton University Press, edition 1, volume 1, number 8973, April.
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