Download this Paper Open PDF in Browser

Sovereign Contagion in Europe: Evidence from the CDS Market

Quaderni DSE Working Paper N° 863

42 Pages Posted: 23 Jan 2013 Last revised: 28 Feb 2013

Paolo Manasse

Università degli Studi di Bologna - Department of Economics; IGIER, Bocconi University; International Monetary Fund (IMF) - Fiscal Affairs Department

Luca Zavalloni

University of Bologna; Bocconi University - IGIER - Innocenzo Gasparini Institute for Economic Research; University of Warwick

Date Written: January 18, 2013

Abstract

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.

Keywords: Sovereign Debt, Contagion, Crisis, Eurozone, CDS, Financial Markets

JEL Classification: E44, F34, G01, G12, G15, H63

Suggested Citation

Manasse, Paolo and Zavalloni, Luca, Sovereign Contagion in Europe: Evidence from the CDS Market (January 18, 2013). Quaderni DSE Working Paper N° 863. Available at SSRN: https://ssrn.com/abstract=2205029 or http://dx.doi.org/10.2139/ssrn.2205029

Paolo Manasse (Contact Author)

Università degli Studi di Bologna - Department of Economics ( email )

Via Strada Maggiore, 45
I-40125 Bologna
Italy
+39 05 1209 2613 (Phone)

IGIER, Bocconi University

Via Sarfatti 25
20136 Milan, MI 20136
Italy
+39 02 5836 3326 (Phone)

International Monetary Fund (IMF) - Fiscal Affairs Department ( email )

700 19th Street, NW
Washington, DC 20431
United States

Luca Zavalloni

University of Bologna ( email )

Piazza Scaravilli 2
Bologna, 40100
Italy

Bocconi University - IGIER - Innocenzo Gasparini Institute for Economic Research ( email )

Via Roentgen 1
Milan, 20136
Italy

University of Warwick ( email )

Gibbet Hill Rd.
Coventry, West Midlands CV4 8UW
United Kingdom

Paper statistics

Downloads
322
Rank
77,261
Abstract Views
1,362