ECB policy and Eurozone fragility: Was De Grauwe right?

Saka, O., Fuertes, A. & Kalotychou, E. (2015). ECB policy and Eurozone fragility: Was De Grauwe right?. Journal of International Money and Finance, 54, pp. 168-185. doi: 10.1016/j.jimonfin.2015.03.002

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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, France, Belgium 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 five Eurozone countries, but only during the pre-announcement period. Altogether these findings support the fragility hypothesis and endorse the OMT program.

Item Type: Article
Additional Information: © 2015, Elsevier. Licensed under the Creative Commons Attribution-NonCommercial-NoDerivatives 4.0 International
Uncontrolled Keywords: Sovereign debt; Eurozone fragility; Self-fulfilling dynamics; European Central Bank; Outright Monetary Transactions
Subjects: H Social Sciences > HG Finance
J Political Science > JZ International relations
Divisions: Cass Business School > Faculty of Finance

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