A Market-Based Analysis of Italy’s Redenomination Risk: between EMU Limits and Eurosceptic Sentiments

Abstract

Since the global financial crisis Eurozone’s architectural flaws and risk segregating policies have raised an issue of euro sustainability for several member countries. This has often resulted in anti-Europeanist sentiments and rising consensus to populist parties. Italy, in particular, in recent years has experienced periodic upsurges in redenomination risk associated with a possible withdrawal from the monetary union. The present work analyzes this risk and its contribution to the country’s sovereign risk since September 2014. The main findings are that redenomination risk can become an important component of government yields and is sensitive to the internal political climate and to the European solidarity towards distressed countries. In particular, in front of the 2020’s pandemic shock, the orderly and decisive conduct of the Italian political leadership and the support interventions by the European institutions have kept redenomination risk under control, indicating the way forward to successfully pursue the European project.

Keywords: Euro break-up, redenomination risk, CDS, ISDA basis, Italexit, risk sharing

JEL Classification: E02, E44, E50, E58, G01, G12, G15, H63