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Sovereign CDS Spreads in Europe; The Role of Global Risk Aversion, Economic Fundamentals, Liquidity, and Spillovers

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  • Frigyes F Heinz
  • Yan M Sun

Abstract

By analysing data from January 2007 to December 2012 in a panel GLS error correction framework we find that European countries’ sovereign CDS spreads are largely driven by global investor sentiment, macroeconomic fundamentals and liquidity conditions in the CDS market. But the relative importance of these factors changes over time. While during the 2008/09 crisis weak economic fundamentals (such as high current account decifit, worsening underlying fiscal balances, credit boom), a drop in liquidity and a spike in risk aversion contributed to high spreads in Central and Eastern and South-Eastern European (CESEE) countries, a marked improvement in fundamentals (e.g. reduction in fiscal deficit, narrowing of current balances, gradual economic recovery) explains the region’s resilience to financial market spillovers during the euro area crisis. Our generalised variance decomposition analyisis does not suggest strong direct spillovers from the euro area periphery. The significant drop in the CDS spreads between July 2012 and December 2012 was mainly driven by a decline in risk aversion as suggested by the model’s out of sample forecasts.

Suggested Citation

  • Frigyes F Heinz & Yan M Sun, 2014. "Sovereign CDS Spreads in Europe; The Role of Global Risk Aversion, Economic Fundamentals, Liquidity, and Spillovers," IMF Working Papers 14/17, International Monetary Fund.
  • Handle: RePEc:imf:imfwpa:14/17
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    Citations

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    Cited by:

    1. Dufrénot, Gilles & Gente, Karine & Monsia, Frédia, 2016. "Macroeconomic imbalances, financial stress and fiscal vulnerability in the euro area before the debt crises: A market view," Journal of International Money and Finance, Elsevier, vol. 67(C), pages 123-146.
    2. Brůha, Jan & Kočenda, Evžen, 2018. "Financial stability in Europe: Banking and sovereign risk," Journal of Financial Stability, Elsevier, vol. 36(C), pages 305-321.
    3. Aristei, David & Martelli, Duccio, 2014. "Sovereign bond yield spreads and market sentiment and expectations: Empirical evidence from Euro area countries," Journal of Economics and Business, Elsevier, vol. 76(C), pages 55-84.
    4. Gábor Kutasi, 2017. "Unsustainable Public Debt in a European Fiscal Union?," Revista Finanzas y Política Económica, Universidad Católica de Colombia, vol. 9(1), pages 25-39, February.
    5. Erce, Aitor, 2015. "Bank and sovereign risk feedback loops," Globalization Institute Working Papers 227, Federal Reserve Bank of Dallas.
    6. repec:pal:imfecr:v:66:y:2018:i:4:d:10.1057_s41308-018-0066-4 is not listed on IDEAS
    7. repec:pal:assmgt:v:19:y:2018:i:2:d:10.1057_s41260-017-0068-1 is not listed on IDEAS
    8. Irina Balteanu & Aitor Erce, 2018. "Linking Bank Crises and Sovereign Defaults: Evidence from Emerging Markets," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 66(4), pages 617-664, December.
    9. Cavallaro, Eleonora & Maggi, Bernardo, 2016. "State of confidence, overborrowing and macroeconomic stabilization in out-of-equilibrium dynamics," Economic Modelling, Elsevier, vol. 59(C), pages 210-223.
    10. repec:kap:revdev:v:21:y:2018:i:1:d:10.1007_s11147-017-9134-6 is not listed on IDEAS
    11. Kocsis, Zalan & Monostori, Zoltan, 2016. "The role of country-specific fundamentals in sovereign CDS spreads: Eastern European experiences," Emerging Markets Review, Elsevier, vol. 27(C), pages 140-168.
    12. Markus Eller & Thomas Reininger, 2016. "The influence of sovereign bond yields on bank lending rates: the pass-through in Europe," Focus on European Economic Integration, Oesterreichische Nationalbank (Austrian Central Bank), issue 2, pages 54-78.
    13. Balteanu, Irina & Erce, Aitor, 2014. "Bank crises and sovereign defaults in emerging markets: exploring the links," Globalization Institute Working Papers 184, Federal Reserve Bank of Dallas.
    14. Irina Balteanu & Aitor Erce, 2014. "Banking crises and sovereign defaults in emerging markets: exploring the links," Working Papers 1414, Banco de España;Working Papers Homepage.

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