Sovereign Contagion in Europe: Evidence from the CDS Market

Manasse, Paolo ; Zavalloni, Luca (2013) Sovereign Contagion in Europe: Evidence from the CDS Market. Bologna: Dipartimento di Scienze economiche DSE, p. 42. DOI 10.6092/unibo/amsacta/3905. In: Quaderni - Working Paper DSE (863). ISSN 2282-6483.
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This paper addresses the following questions. Is there evidence of financial contagion in the Eurozone? To what extent a country's vulnerability to contagion depends on "fundamentals" as opposed the government's "credibility"? We look at the empirical evidence on European sovereigns CDS spreads and estimate an econometric model where a crucial role is played by time varying parameters. We model CDS spread changes at country level as reflecting three different factors: a Global sovereign risk factor, a European sovereign risk factor and a Financial intermediaries risk factor. Our main findings are as follows. First, Unlike the US subprime crisis which affected all European sovereign risks, the Greek crisis is largely a matter concerning the Euro Zone. Second, differences in vulnerability to contagion within the Eurozone are even more remarkable: the core Eurozone members become less vulnerable to EUZ contagion, possibly due to a safe-heaven effect, while peripheric countries become more vulnerable. Finally, market fundamentals go a long way in explaining these differences: they jointly explain between 54 and 80% of the cross-country variation in idiosyncratic risks and in the vulnerability to contagion, largely supporting the "wake-up call" hypothesis according to which market participants become more wary of market fundamentals during financial crises.

Document type
Monograph (Working Paper)
Manasse, Paolo
Zavalloni, Luca
Sovereign Debt, Contagion, Crisis, Eurozone, CDS, Financial Markets
Deposit date
12 Dec 2013 14:08
Last modified
19 Feb 2014 08:51

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