Contagion in the Euro crisis: capital flows and trade linkages

Eleonora Cutrini and
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Eleonora Cutrini and: University of Macerata
Authors registered in the RePEc Author Service: Eleonora Cutrini ()

No 44-2014, Working Papers from Macerata University, Department of Studies on Economic Development (DiSSE)

Abstract: Against the backdrop of the contagion literature, the paper analyses the impact of financial and trade linkages on sovereign bonds spreads in the Eurozone crisis. Using quarterly data for a sample of EMU countries during the period 2000-2013, we estimate fixed-effect panel models with Driscoll and Kraay standard errors that are robust to general forms of spatial and temporal dependence. Our main results can be summarized as follows. First, we suggest that the "sudden stop" of capital inflow toward the peripheral sovereign debt triggered a re-segmentation of financial markets and economic systems along national borders, with negative implications for risk sharing and the efficient allocation of capital. The "home bias" effect - i.e. the increase in the share of sovereign debt held by domestic banks - worsened the country-specific risk because the twin crisis (sovereign and banking) began to be conceived as more closely intertwined within countries than before. Second, the structure of international trade helps to account for the geographic scope of contagion, even after controlling for macroeconomic and fiscal vulnerabilities. Finally, the potential influence of wider financial spillovers related to the emerging markets' decoupling hypothesis is confirmed by our analysis. However, the "substitution-effect" of public debt securities of stand-alone emerging countries has affected more the sovereign spreads in the core than in the periphery.

Keywords: Eurozone; decoupling; sovereign debt crisis; contagion; trade and financial linkages; foreign debt (search for similar items in EconPapers)
JEL-codes: E44 F36 F40 F42 G12 H63 (search for similar items in EconPapers)
Date: 2014-10, Revised 2014-11
New Economics Papers: this item is included in nep-eec, nep-mac and nep-opm
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