Measuring Sovereign Contagion in Europe

Abstract

This paper analyzes sovereign risk shift-contagion, i.e. positive and significant changes in the propagation mechanisms, using bond yield spreads for the major Eurozone countries. By emphasizing the use of two econometric approaches based on quantile regressions (standard quantile regression and Bayesian quantile regression with heteroskedasticity) we find that the propagation of shocks in euro's bond yield spreads shows almost no presence of shiftcontagion in the sample periods considered (2003-2006, Nov. 2008-Nov. 2011, Dec. 2011-Apr. 2013).Shock transmission is no different on days with big spread changes and small changes. This is the case even though a significant number of the countries in our sample have been extremely affected by their sovereign debt and fiscal situations.The risk spillover among these countries is not affected by the size or sign of the shock, implying that so far contagion has remained subdued. However, the US crisis, does generate a change in the intensity of the propagation of shocks in the Eurozone between the 2003-2006 pre-crisis period and the Nov. 2008-Nov. 2011 post-Lehman one, but the coefficients actually go down, not up! All the increases in correlation we have witnessed over the last years come from larger shocks and the heteroskedasticity in the data, not from similar shocks propagated with higher intensity across Europe.These surprising, but robust, results emerge because this is the first paper, to our knowledge, in which a Bayesian quantile regression approach allowing for heteroskedasticity is used to measure contagion. This methodology is particularly well-suited to deal with nonlinear and unstable transmission mechanisms especially when asymmetric responses to sign and size are suspected. Measuring Sovereign Contagion in Europe April 2015Abstract This paper analyzes sovereign risk shift-contagion, i.e. positive and significant changes in the propagation mechanisms, using bond yield spreads for the major eurozone countries. By emphasizing the use of two econometric approaches based on quantile regressions (standard quantile regression and Bayesian quantile regression with heteroskedasticity) we find that the propagation of shocks in euro's bond yield spreads shows almost no presence of shift-contagion. All the increases in correlation we have witnessed over the last years come from larger shocks propagated with higher intensity across Europe.JEL Classification: E58, F34, F36, G12, G15.

Measuring Bilateral Spillover and Testing Contagion on Sovereign Bond Markets in Europe

“…It demonstrates that most of this spillover is driven by larger sized shocks being transmitted in pretty much the same way as prior to the crisis. Caporin et al (2013) show similar evidence -with Bayesian quantile regressions -of a rather constant propagation of shocks on European CDS markets. Our result also complements Mink and de Haan (2013) arguing that price of sovereign debt of Portugal, Ireland, and Spain, responded to both news about the economic situation of Greece and news about a Greek bail-out as captured by abnormal returns on sovereign bonds.…”

“…Common political and economic events at EU level have had a contemporaneous impact across EU countries. As a result, many of the previously developed tests for contagion suffer from a simultaneity bias between correlated asset prices, and from changes in co-movement unrelated to transmission but due to modification of the size and volatility of the shocks (Caporin et al, 2013).…”

Spillover dynamics for systemic risk measurement using spatial financial time series models

“…Our empirical model contains two regressors that capture the state of the European financial market, see also Caporin et al (2013). The first variable is the change in the volatility index VStoxx.…”

“…Leschinski and Bertram (2013) find contagion effects in European sovereign bond spreads using the simultaneous equations approach of Pesaran and Pick (2007). Caporin et al (2013), on the other hand, employ Bayesian quantile regressions, and conclude that comovements in European credit spreads during the debt crisis are only due to increased volatities, but not contagion.…”

Deciphering financial contagion in the euro area during the crisis

“…Most of the dummy variables capturing shocks specific to a given country are also significant in the equations of some other countries. 7 Out of the 61 country-specific shocks in our sample, 50 of these have been transmitted to at least one other country beyond the normal channels of interdependence.…”