From Bear Stearns to Anglo Irish: How Eurozone Sovereign Spreads Related to Financial Sector Vulnerability

40 Pages Posted: 30 Jun 2009

See all articles by Ashoka Mody

Ashoka Mody

International Monetary Fund (IMF) - Research Department

Date Written: May 2009

Abstract

This paper attempts to explain the recent rise and differentiation of sovereign spreads across the countries of the eurozone. Following the onset of the subprime crisis in July 2007, spreads rose but mainly on account of common global factors. The rescue of Bear Stearns in March 2008 marked a turning point. Countries thereafter were increasingly differentiated. Sovereign spreads of a eurozone country tended to rise when the prospects of its domestic financial sector worsened. It appears, therefore, that the rescue of Bear Stearns created a link between financial sector vulnerabilities and a larger contingent liability on public finances. Following the failure of Lehman Brothers, spreads also rose faster for countries with higher ratios of public debt-to-GDP. These transitional dynamics appear to have concluded with the nationalization of Anglo Irish: sovereign spreads throughout the eurozone jumped, with the jump emphasizing the differentiation by financial sector vulnerability and public debt levels. The results imply that, to varying degrees, countries may have moved to a new regime of weak economic outlook, financial sector fragilities, and strains on public finances.

Keywords: Banking crisis, Bonds, Credit risk, Cross country analysis, European Union, Financial risk, Financial sector, Public debt, Public finance, Sovereign debt

Suggested Citation

Mody, Ashoka, From Bear Stearns to Anglo Irish: How Eurozone Sovereign Spreads Related to Financial Sector Vulnerability (May 2009). IMF Working Paper No. 09/108, Available at SSRN: https://ssrn.com/abstract=1424844

Ashoka Mody (Contact Author)

International Monetary Fund (IMF) - Research Department ( email )

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