Systemic risk, sovereign yields and bank exposures in the euro crisis (original) (raw)
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The sovereign debt crisis and the euro area
2013
This publication collects the papers presented at the workshop entitled "The sovereign debt crisis and the euro area", held at the Bank of Italy in Rome on 15 February 2013. In recent years the Economic Research and International Relations Area of the Bank of Italy has conducted several analyses on the impact of the sovereign debt crisis on the financial system and the economy in Italy and other euro-area countries. The workshop provided a first opportunity to discuss the results of those analyses with representatives of the academic world. The volume comprises three sections, which examine the main mechanisms whereby the tensions in the government bond markets due to the sovereign debt crisis were transmitted to the banking system and then to the real economy.
Sovereigns and Banks in the Euro Area: A Tale of Two Crises
SSRN Electronic Journal, 2015
Institute of Applied Economics (IREA) in Barcelona was founded in 2005, as a research institute in applied economics. Three consolidated research groups make up the institute: AQR, RISK and GiM, and a large number of members are involved in the Institute. IREA focuses on four priority lines of investigation: (i) the quantitative study of regional and urban economic activity and analysis of regional and local economic policies, (ii) study of public economic activity in markets, particularly in the fields of empirical evaluation of privatization, the regulation and competition in the markets of public services using state of industrial economy, (iii) risk analysis in finance and insurance, and (iv) the development of micro and macro econometrics applied for the analysis of economic activity, particularly for quantitative evaluation of public policies. IREA Working Papers often represent preliminary work and are circulated to encourage discussion. Citation of such a paper should account for its provisional character. For that reason, IREA Working Papers may not be reproduced or distributed without the written consent of the author. A revised version may be available directly from the author. Any opinions expressed here are those of the author(s) and not those of IREA. Research published in this series may include views on policy, but the institute itself takes no institutional policy positions.
Systemic Risk and Home Bias in the Euro Area
2013
According to conventional indicators, the euro-area financial integration has receded since 2007, mainly in the money market, sovereign debt market and uncollateralized credit markets. But price-based measures of debt market segmentation are inappropriate when solvency risk differs across countries: only the component of yield differentials that is not a reward for the issuer’s credit risk may reflect segmentation. We apply this idea to the euro sovereign debt market, using a dynamic factor model to decompose yield differentials in a country-specific and a common (or systemic) risk component. As the country-specific component dominates, purging yields from it produces much smaller measures of bond market segmentation than conventional ones for the crisis period. We also investigate how the home bias of banks’ sovereign portfolios – a quantity-based measure of segmentation – is related to yield differentials, by estimating a vector error-correction model on 2008-12 monthly data. We f...
A Tale of Two Euro-Zones: Banks' Funding, Sovereign Risk & Unconventional Monetary Policies
SSRN Electronic Journal, 2000
The admission by the Greek government on October 18, 2009, of large-scale accounting fraud in its national accounts sparked an unprecedented sovereign debt crisis that rapidly spread to the Eurozone's weakest member states. As the crisis increasingly drove a wedge between a seemingly resilient Eurozone core and its faltering periphery, its first collateral victims were the private banks of the hardest-hit sovereigns. They were rapidly followed by the rest of the Eurozone's banks as a result of their large exposure to not only their home country's sovereign debt, but also to the debt securities of other member states. Measuring each bank's precise exposure to every sovereign issuer became a key issue for credit analysis in the attempt to assess the potential impact of a selective sovereign default if worse came to worst. Yet finding that information in a timely manner is hardly an easy task, as banks are not required to disclose it. Building on the efficient market hypothesis in the presence of informed traders, we tested the sensitivity of each of the largest Eurozone private banks' CDSs to sovereign CDSs using a simple autoregressive model estimated by time-series regressions and panel regressions, comparing the results to news releases to assess its reliability. Eventually, we used the Oaxaca Blinder decomposition to measure whether the unconventional monetary policies, namely the LTRO and the OMT, that the ECB has implemented to stem the crisis have helped banks directly or whether banks were actually helped by the reduction in sovereign CDS spreads.
On the Risk of a Sovereign Debt Crisis in Italy
Intereconomics
The intention for the Italian government to stimulate business activity via large increases in government spending is not in line with the stabilisation of the public debt ratio. Instead, if such policy were implemented, the risk of a sovereign debt crisis would be high. In this article, we analyse the capacity of the Italian economy to shoulder sovereign debt under different scenarios. We conclude that focusing on growth enhancing structural reforms, would allow for moderate increases in public expenditure.
Sovereign Exposures of European Banks: It Is Not All Doom
SSRN Electronic Journal, 2019
In this paper we investigate whether or not observed changes in the composition of the sovereign bond portfolios of European banks are determined by a risk-return trade-off. Banks have been shown to disproportionally invest in bonds issued by their domestic sovereign, causing a negative bank-sovereign doom loop. Several motivations for such behavior have been demonstrated in the extant literature, such as e.g., search for yield or moral suasion, which from an investment perspective all involve some degree of irrational behavior. We depart from this approach and investigate the risk-return trade-off in the bank sovereign bond portfolios. We use data from all stress tests and transparency exercises conducted by the EBA between 2011 and 2018 for a sample of 76 European banks. Using the Sharpe ratio for the risk-return assessment, we find that over the entire period banks' investments and divestments of sovereign bonds are characterized by rational risk-return considerations. Moreover, both bond risk (measured by the standard deviation of bond returns) as well as sovereign risk (sovereign CDS spreads) are negatively related to bond buying, implying that, on average, banks do not engage in excessive risk-taking behavior in their sovereign bond portfolios. Our main conclusion is that over the 2011-2018 period banks may have exhibited spells of excessive risk behavior in their sovereign bond buying, but over the entire period their sovereign bond investments exhibit a sound risk-return trade-off. These findings have implications for policy initiatives to tackle concentrations in sovereign bond holdings by European banks.
In this study we build upon a Markov-Switching Bayesian Vector Autoregression (MSBVAR) model to study how the credit default swaps (CDS) market in the euro area becomes an important chain in the propagation of shocks through the entire financial system. We find that an unexpected increase in the banks’ (sovereign) CDS spread is followed by an increase in the sovereign (banks’) CDS spreads. An unedited insight that emanates from this research is that the aforementioned effects become stronger in periods of elevated uncertainty in the CDS market. Several implications can be derived from this research. First, in line with the existing literature, we identify that government interventions in the banking sector deteriorate the credit risk of sovereign debt. Second, higher risk premium that is required by investors for holding riskier government bonds depresses the sovereign debt market, it impairs balance sheets of the banking sector, and it depresses the collateral value of loans leading to bank retrenchment. The ensuing two-way banking-fiscal feedback loop indicates that government interventions do not necessarily stabilize the banking sector. Indeed, the prospect of government intervention allow banks to be more leveraged and, hence, more vulnerable to a sovereign default. We also document a negative response of the EUROSTOXX stock index and positive response of the VSTOXX volatility index to a unexpected increase in the banks’ and sovereign CDS spread. Our findings are corroborated by several robustness checks.
2014
We develop a two-country model with an explicitly microfounded interbank market and sovereign default risk. Both features interact and give rise to a debt-banks-credit loop by which sovereign default risk can have large contractionary effects on the economy. Calibrated to the Euro Area, the model performs well in matching key business cycle facts on real, financial and fiscal time series. We then use the model to assess the effects of the Great Recession and quantify the potential effects of alternative unconventional policies on the dynamics of European economies. All the policies considered can bring sizable reductions in the welfare losses from the Great Recession, but policies targeted at sovereign bonds and interbank loans are more efficient than standard credit interventions.
Journal of Financial Management, Markets and Institutions (ISSN 2282-717X) Fascicolo 1, gennio-giugno 2013 Copyright c by Società editrice il Mulino, Bologna. Tutti i diritti sono riservati. Per altre informazioni si veda https://www.rivisteweb.it Licenza d'uso L'articolò e messo a disposizione dell'utente in licenza per uso esclusivamente privato e personale, senza scopo di lucro e senza fini direttamente o indirettamente commerciali. Salvo quanto espressamente previsto dalla licenza d'uso Rivisteweb, ` e fatto divieto di riprodurre, trasmettere, distribuire o altrimenti utilizzare l'articolo, per qualsiasi scopo o fine. Tutti i diritti sono riservati. Abstract This work estimates a reduced model of the determinants of the 10-year yield spreads relative to Germany for 10 Eurozone countries. Results show that since the inception of the 2007 crisis, spreads have exhibited a rising time-dependent component. Country specific estimated responses to financial turmoil ...
Euro area sovereign risk during the crisis
2009
The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate.