Flight-to-liquidity flows in the euro area sovereign debt crisis

In periods of market stress, portfolio reallocations in bond markets reflect both safety and liquidity concerns. Using sovereign and national agency bonds, we construct indicators of liquidity premia in major euro area bond markets; we document the weakening of the correlation between core and periphery market liquidity during the euro area sovereign bond crisis; and we identify several episodes of significant flight-to-liquidity (FTL) flows above and beyond flight-to-safety (FTS) spells in the period 2009-13. We show that FTL flows led to significant inverse moves in sovereign bond yields in euro area core and periphery markets. Moreover, FTL flows triggered declines in core and periphery stock markets and are associated with lower macroeconomic confidence in the euro area as a whole, which underscores the importance of FTL episodes for investors and policymakers alike.