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Contagion in the Euro crisis: capital flows and trade linkages

Author

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  • Eleonora Cutrini and Giorgio Galeazzi

    (University of Macerata)

Abstract

Against the backdrop of the contagion literature, the paper analyses the impact of financial and trade linkages on sovereign bonds spreads in the Eurozone crisis. Using quarterly data for a sample of EMU countries during the period 2000-2013, we estimate fixed-effect panel models with Driscoll and Kraay standard errors that are robust to general forms of spatial and temporal dependence. Our main results can be summarized as follows. First, we suggest that the "sudden stop" of capital inflow toward the peripheral sovereign debt triggered a re-segmentation of financial markets and economic systems along national borders, with negative implications for risk sharing and the efficient allocation of capital. The "home bias" effect - i.e. the increase in the share of sovereign debt held by domestic banks - worsened the country-specific risk because the twin crisis (sovereign and banking) began to be conceived as more closely intertwined within countries than before. Second, the structure of international trade helps to account for the geographic scope of contagion, even after controlling for macroeconomic and fiscal vulnerabilities. Finally, the potential influence of wider financial spillovers related to the emerging markets' decoupling hypothesis is confirmed by our analysis. However, the "substitution-effect" of public debt securities of stand-alone emerging countries has affected more the sovereign spreads in the core than in the periphery.

Suggested Citation

  • Eleonora Cutrini and Giorgio Galeazzi, 2014. "Contagion in the Euro crisis: capital flows and trade linkages," Working Papers 44-2014, Macerata University, Department of Studies on Economic Development (DiSSE), revised Nov 2014.
  • Handle: RePEc:mcr:wpaper:wpaper00044
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    More about this item

    Keywords

    Eurozone; decoupling; sovereign debt crisis; contagion; trade and financial linkages; foreign debt;

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration
    • F40 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - General
    • F42 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Policy Coordination and Transmission
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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