Abstract
ABSTRACTThis paper investigates the effect of European monetary policies on Eurozone countries’ sovereign risks. We control for interdependencies across individual variables within and across countries using a global VAR specification weighting transmission by their fiscal position. We find evidence of positive correlation between sovereign bond CDS and risk aversion for almost all countries in the Eurozone. The effects are larger after the 2012 Greek debt crisis. When the ECB increases its refinancing rate or there is a decline in money aggregates (i.e., M3), we observe an increase in sovereign bonds’ risk of all countries (except Greece). In contrast, monetary policy tightening shocks have the opposite impact on Greece due to a differentiation effect.
Highlights
The 2007–2008 financial turmoil urged governments of advanced economies to step in to the center of financial systems and assume the risk of privately held debt across capital markets
With multiple European countries being in the center of debt troubles, the rapidly weakening situation in the 'Eurozone attracted a number of empirical papers covering the issues of sovereign risk in the euro area
global vector autoregressive (VAR) (GVAR) results we present and interpret the result of seemingly unrelated regression (SUR) using GVAR models and impulse response functions (IRF) for country-specific shocks and monetary shocks
Summary
The 2007–2008 financial turmoil urged governments of advanced economies to step in to the center of financial systems and assume the risk of privately held debt across capital markets. After late 2008 with financial markets realizing the impact of the crisis, sovereign bond yield spreads between Germany and other Euro area countries started to widen significantly. Recent studies confirm that the start of EMU and 2008–09 financial crisis change the effect of government debt and deficit on sovereign bond yields within the Euro area and find that Germany was perceived as a “safe-haven” in international financial market after 2008–09 financial crisis (Bernoth, von Hagen, and Schuknecht (2012)). The third commonly used determinant of spread yields is liquidity risk This a very important factor as countries within the Euro area have not perfect control over monetary decisions which are taken by the central institutions, i.e., European Central Bank (ECB).
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