ECB Policy and Eurozone Fragility: Was De Grauwe Right?

36 Pages Posted: 28 Jun 2014 Last revised: 20 Mar 2015

See all articles by Orkun Saka

Orkun Saka

University of Sussex; London School of Economics & Political Science (LSE)

Ana-Maria Fuertes

Cass Business School, City University of London

Elena Kalotychou

Cass Business School, City, University of London

Date Written: February 20, 2015

Abstract

Paul De Grauwe’s Eurozone fragility hypothesis states that sovereign debt markets in a monetary union without a lender-of-last-resort are vulnerable to self-fulfilling dynamics fuelled by pessimistic investor sentiment that can trigger default. We test this contention by applying an eclectic methodology to a two-year window around Mario Draghi’s “whatever-it-takes” pledge that can be understood as the implicit announcement of the Outright Monetary Transactions (OMT) program. A principal components analysis reveals that the perceived commonality in default risk among peripheral and core Eurozone sovereigns increased after the announcement. An event study reveals significant pre-announcement news transmission from Spain to Italy, Belgium, France and Austria that clearly dissipates post-announcement. Country-specific regressions of CDS spreads on systematic risk factors reveal frequent days of large adverse shocks affecting simultaneously those same Eurozone countries during the pre-announcement period. Altogether these findings support the fragility hypothesis and endorse the OMT program.

Keywords: Sovereign debt; Eurozone fragility; Self-fulfilling dynamics; European Central Bank; Outright Monetary Transactions.

JEL Classification: E44, F36, G15, C52

Suggested Citation

Saka, Orkun and Fuertes, Ana-Maria and Kalotychou, Elena, ECB Policy and Eurozone Fragility: Was De Grauwe Right? (February 20, 2015). Journal of International Money and Finance, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2459882 or http://dx.doi.org/10.2139/ssrn.2459882

Orkun Saka

University of Sussex ( email )

Sussex House
Falmer
Brighton, Sussex BNI 9RH
United Kingdom

London School of Economics & Political Science (LSE) ( email )

Houghton Street
London, WC2A 2AE
United Kingdom

Ana-Maria Fuertes (Contact Author)

Cass Business School, City University of London ( email )

Faculty of Finance
106 Bunhill Row
London, EC1Y 8TZ
United Kingdom
+44 207 477 0186 (Phone)
+44 207 477 8881 (Fax)

HOME PAGE: http://www.city.ac.uk/people/academics/ana-maria-fuertes

Elena Kalotychou

Cass Business School, City, University of London ( email )

106 Bunhill Row
London, EC1Y 8TZ
Great Britain

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