Peripheral Euro Area Countries Research Articles

Public debt determinants: A time-varying analysis of core and peripheral Euro area countries

This study employs a Bayesian Interacted Panel VAR model to estimate time-varying Generalized Forecast Error Variance Decomposition, analyzing how key determinants affect debt in Core and Peripheral Euro Area countries. Results highlight varying effects of determinants across periods and subgroups.

Central bank purchases of sovereign bonds in the euro area, the random walk hypothesis, and different measures of risk

Abstract The large purchase of public sector bonds (PSPP) by the ECB constitutes an interesting special case of quantitative easing (QE). It involved the purchase of risky, peripheral euro area government bonds—not by the ECB itself but by the national central banks at their own risk. The PSPP can be assimilated into a buy-back financed with senior debt, which should reduce the value of the remaining debt. Theory thus suggests that the PSPP should not be expected to have a positive impact on peripheral risk spreads. Empirical studies try to measure the impact of the asset purchases of central banks (QE) using the market reaction at the announcement date. The announcement effects are taken to be permanent because long-term rates are assumed to follow a random walk. We show that this assumption is not warranted for the risk spreads on bonds or the credit default swaps of peripheral euro area countries.

Sovereign debt ratings and the country composition of cross-border holdings of euro area sovereign debt

This paper documents how sovereign debt ratings shape the country composition of euro area cross-border holdings of euro area sovereign debt, using granular sectoral security holdings statistics for the period 2009Q4 until 2016Q1. Credit risk is the main risk for bond investors when investing in bonds that are issued in the same currency as the currency of the investor’s home country. Sovereign debt ratings provided by rating agencies give investors key information on the creditworthiness of governments. The results in this paper show that investors respond differently to credit ratings. In particular, we find that investors from core euro area countries respond more to credit ratings than investors from peripheral euro area countries. The results show that banks and insurance companies in core countries hold significantly more sovereign bonds of countries with higher credit ratings. In peripheral countries we do not find a positive relationship between ratings and sovereign bond holdings.

Trade and capital flows: Substitutes or complements? An empirical investigation

AbstractThis paper examines the linkages between the trade of goods and financial assets. Do both flows behave as complements (implying a positive correlation) or as substitutes (negative correlation)? Although a classic topic in international macroeconomics, the empirical evidence has remained relatively scarce so far, in particular for the Euro area where trade and financial imbalance played a prominent role in the build‐up of the European sovereign debt crisis. Consequentially, we use a novel dataset, providing estimates for financial flows and its four main categories for 42 countries and covering the period from 2002 to 2012, to test the so‐called trade‐finance nexus. Since theoretical models stress that both flows might be influencing each other simultaneously, we introduce a novel time‐varying instrumental variable based on capital control restrictions to estimate a causal effect. The results of the gravity regressions support theories that underline the complementarity between exports and capital flows. When testing the trade‐finance nexus for different types of capital flows, the estimated coefficient is most pronounced for foreign direct investment, in line with theories stressing informational frictions. Robustness checks in the form of different estimation methods, alternative proxies for capital flows and sample splits confirm the positive relationship. Interestingly, the trade‐finance nexus does not differ among countries belonging to the EMU, the European Union or among core and peripheral Euro area countries.

The dynamic effects of monetary policy and government spending shocks on unemployment in the peripheral Euro area countries

In this paper we study the response of unemployment to monetary policy and government spending shocks in the peripheral Euro-area countries. By applying the structural near-VAR methodology, we jointly model area-wide and national variables. Our main finding is that fiscal multipliers vary across countries and the results are consistent with the prediction of the standard New Keynesian model only in Italy and Greece. Instead, in Ireland, Portugal and Spain increases in government spending are recessionary. Thus we find that Keynesian results of fiscal policy seem to prevail in high public-debt countries, whereas non-Keynesian outcomes seem to characterize high private-debt countries. As for the monetary policy shock, we find that it plays an important role, jointly with the other area-wide shocks, as a long-term driver of national unemployment.

The sovereign-bank nexus in peripheral euro area: Further evidence from contingent claims analysis

New evidence is presented on the nexus between the sovereign and banking sector risk. Applying the contingent claims methodology to the peripheral euro area countries over the 2004Q4-2013Q2 period, we build indicators of sovereign and bank risk and assess their interconnection in comparison with existing market-based indicators of bank and sovereign distress. We use three different statistical measures of interdependence based on principal components analysis, Granger causality framework and Diebold-Yilmaz’s connectedness index. The empirical results show strong interconnection and co-movement between country-level banking and sovereign risk indicators. We also find evidence of bi-directional bank-sovereign causal linkages only for Spain during the European sovereign debt crisis period. For the late crisis period, we detect weak interrelationship and more divergence across the various risk indicators. Our findings indicate that secondary and derivatives market indices are more driven by common underlying factors than are contingent claim based risk measures. Finally, our results also suggest that market participants risk appetite was the main channel of risk transmission between sovereigns and banks for the countries under study during the sample period.

The Impact of Sovereign Debt Ratings on Euro Area Cross-Border Holdings of Euro Area Sovereign Debt

This paper documents how sovereign debt ratings shape euro area cross-border holdings of euro area sovereign debt, using granular sectoral security holdings statistics for the period 2009Q4 until 2016Q1. Credit risk is the main risk for bond investors when investing in bonds that are issued in the same currency as the currency of the investor’s home country. Sovereign debt ratings provided by rating agencies give investors key information on the creditworthiness of governments. The results in this paper show that investors respond differently to credit ratings. In particular, we find that investors from core euro area countries respond more to credit ratings than investors from peripheral euro area countries. The results show that banks, insurance companies, pension funds and investment funds in core countries all significantly increase their bond holdings when credit ratings improve. In peripheral countries we document only a positive effect for pension funds and find no relationship between ratings and bond holdings for the other investor sectors. Finally, we find non-linearities in the relationship between bond holdings and credit ratings.

On the Macroeconomic Performance of the Euro Area

This paper examines whether Euro Area countries would have faced a more favorable inflation output variability tradeoff without the Euro. We provide evidence that this claim is true for the periods of the Great Recession and the European Sovereign Debt Crisis. For the Euro Area as a whole, the deterioration of the tradeoff becomes insignificant with Draghi’s ‘whatever it takes’ announcement onwards. However, our more detailed analysis shows that the detrimental effect of the Euro is more severe for peripheral Euro Area countries and that ECB policies have been less effective for these countries. These findings point to structural differences among Euro Area countries as the explanation of the detrimental effect of the Euro as ECB policies can be denoted ‘one size must fit all’ policies. We base our results on a novel empirical strategy that, consistent with monetary theory, models the joint determination of the variability of inflation and output conditional on structural supply shocks. Moreover, our findings are robust to potential endogeneity concerns related to adopting the Euro.

Corporate debt and investment: A firm-level analysis for stressed euro area countries

This paper investigates the link between corporate debt and investment for a group of five peripheral euro area countries. Using firm-level data from 2005 to 2014, we postulate a non-linear corporate leverage-investment relationship and derive thresholds beyond which leverage has a negative and significant impact on investment. The investment sensitivity of debt increased after 2008 when financial distress intensified and firms had a lower capacity to finance investment from internal sources of funds. Our results also suggest that even moderate levels of debt can exert a negative influence on investment for smaller firms or when profitability is low.

'Incorporating Creditors' Seniority into Contingent Claim Models: Application to Peripheral Euro Area Countries'

We analyze the interconnection between the sovereign and banking sector risk in the peripheral euro area countries over the 2004Q4-2013Q2 period. Applying the contingent claims methodology, we build indicators of sovereign and banking sector risk (incorporating both market and balance sheet based information) and assess their interconnection in comparison with existing market-based indicators of banking and sovereign distress. We use three different statistical measures of interconnection based on principal components analysis, Granger causality network and Diebold-Yilmaz's connectedness index, and apply them to quarterly credit risk data. The empirical results shows strong connectedness and comovement between country-level banking and sovereign risk indicators. We find evidence of bi-directional bank-sovereign linkage for Spain and Italy during the European sovereign debt crisis period. For the late crisis period, we find weak interconnection and more divergence across the various risk indicators. Our findings also suggest that secondary and derivatives market indices are more driven by common underlying factors than are contingent claim based risk measures.

The Robustness of the Sovereign-Bank Interconnection: Evidence from Contingent Claims Analysis

We analyze the interconnection between the sovereign and banking sector risk in the peripheral euro area countries over the 2004Q4-2013Q2 period. Applying the contingent claims methodology, we build indicators of sovereign and banking sector risk (incorporating both market and balance sheet based information) and assess their interconnection in comparison with existing market-based indicators of banking and sovereign distress. We use three different statistical measures of interconnection based on principal components analysis, Granger causality network and Diebold-Yilmaz's connectedness index, and apply them to quarterly credit risk data. The empirical results show strong connectedness and comovement between country-level banking and sovereign risk indicators. We find evidence of bi-directional bank-sovereign linkage for Spain and Italy during the European sovereign debt crisis period. For the late crisis period, we find weak interconnection and more divergence across the various risk indicators. Our findings also suggest that secondary and derivatives market indices are more driven by common underlying factors than are contingent claim based risk measures.

Incorporating Creditors' Seniority into Contingent Claim Models: Applicarion to Peripheral Euro Area Countries

Incorporating Creditors' Seniority into Contingent Claim Models: Applicarion to Peripheral Euro Area Countries

Sovereign Bond Spreads in the EMU Peripheral Countries. The Role of the Outright Monetary Transactions

The paper examines determinants of sovereign bond spreads (in relation to Germany) of the peripheral euro area countries in the period 2007Q3-2015Q3. The study indicates that the introduction of the Outright Monetary Transactions (OMTs) by the ECB in the third quarter of 2012 led to a change in the sensitivity of the spreads to the developments of certain macroeconomic fundamentals of these economies. In particular, the ratio of public debt to GDP, which significantly and strongly determined the spreads in the period 2007Q3-2012Q2, proved to be insignificant in the period 2012Q3-2015Q3. In addition, the counterfactual analysis carried out shows that the spreads in the analysed countries would have been much higher if the ECB had not decided to introduce this programme.

Sudden stops and current account reversals: the euro area experience

Abstract The paper analyzes the impact of massive capital flows and possible sudden stops on current account reversals. The aim of this paper is to consider the relationship between sudden stops and current account reversals in the eurozone and to explain the possibility of a balance-of-payment crisis within a monetary union. Peripheral eurozone countries experienced significant private-capital inflows from the core countries, followed by unambiguously massive outflows. Due to this, peripheral countries ran sustained current account deficits while core countries ran surpluses. At the end we analyze the evolution of current-account balances in the non-euro area EU countries and the peripheral euro-area countries, and we find out that current account deficits could be maintained over a longer period of time in the peripheral euro-area countries.

At a Glance …: The World Economy

The world economy will grow by 3.3 this year, and by 3.7 per cent in 2014: still below trend.In the developed world, divergence continues; the US will grow just over 2 per cent in each year, while the Euro Area remains in recession and will grow only about I per cent next year.Unemployment remains very high in most countries, and at depression-era rates in some peripheral Euro Area countries.

Stock Market Implied Sovereign CDS During the European Debt Crisis

This paper explores the impact of the European debt crisis on the valuation of sovereign debt in the euro area in a structural model that merges a sovereign country's stock market, CDS market, and its national finances. By estimating the model over the period from July 2007 to April 2012 using CDS data, this study reveals a structural break in the valuation of sovereign debt at the beginning of the European debt crisis. While for core euro-area countries this structural break takes the form of an upward shift of their default barriers that corresponds to an upward shift of their market implied or implicit debt levels, a downward shift is observed for a set of peripheral euro-area countries. These findings are consistent with markets pricing in guarantees and bailout payments between core and peripheral euro-area countries.