Economic Policy Uncertainty and Risk Spillovers in the Eurozone

26 Pages Posted: 24 Jan 2015

See all articles by Oscar Bernal

Oscar Bernal

University of Namur

Jean-Yves Gnabo

Facultés Universitaires Notre-Dame de la Paix (FUNDP)

Grégory Guilmin

University of Namur

Date Written: January 22, 2015

Abstract

This paper focuses on the impact of economic policy uncertainty on risk spillovers within the Eurozone and contributes to these two growing literatures. To this end, we adapt the two-step procedure developed by Adrian and Brunnermeier (2011) in the framework of financial systemic risk to sovereign bond market. Accordingly, we attempt (i) to measure the extent to which distress affecting one given country’s sovereign spreads can affect the Eurozone bond market as a whole and then (ii) to identify the determinants of risk spillovers by using a dynamic panel data model with macroeconomic state variables and economic policy uncertainty (EPU) indices introduced by Baker et al. (2013) as regressors. EPU indices considered concern the four largest Eurozone countries, i.e. Germany, France, Italy and Spain, as well as the United States. The model is estimated with quarterly data for ten countries representing the bulk of debt issuances within the Eurozone over a period ranging from Q4/2008 to Q2/2013. Our results support the idea that economic policy uncertainty in the largest economies of the Eurozone, Germany and France, can create an environment likely to exacerbate the transmission of risk arising from abnormal developments of individual countries’ sovereign spreads to the Eurozone bond market as a whole. In this respect, our results plead for larger effort of Eurozone “leaders” to reduce the uncertainty surrounding their economic policy in periods of crisis not only to avoid adverse effects on their own economies but also to reduce the risk of a destabilization of the Eurozone sovereign bond market as a whole.

Keywords: Euro area, Economic Policy Uncertainty, Risk Spillovers, Government bond spreads, Debt crisis, CoVaR, Quantile regression

JEL Classification: C21, E44, E60, F34, G01, G18

Suggested Citation

Bernal, Oscar and Gnabo, Jean-Yves and Guilmin, Grégory, Economic Policy Uncertainty and Risk Spillovers in the Eurozone (January 22, 2015). Available at SSRN: https://ssrn.com/abstract=2554046 or http://dx.doi.org/10.2139/ssrn.2554046

Oscar Bernal

University of Namur ( email )

8 rempart de la vierge
Namur, 5000
Belgium

Jean-Yves Gnabo

Facultés Universitaires Notre-Dame de la Paix (FUNDP) ( email )

Rempart de la Vierge, 8
Namur B-5000
Belgium

Grégory Guilmin (Contact Author)

University of Namur ( email )

8 rempart de la vierge
Namur, 5000
Belgium

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