Causes and hazards of the euro area sovereign debt crisis: Pure and fundamentals-based contagion

Abstract

This paper tries to contribute to the understanding of sovereign debt crises' pattern by empirically investigating the determinants of the recent euro area crisis to assess if its transmission was due to "pure" or "fundamentals-based" contagion. Using sovereign bond yield spreads with respect to Germany for a sample of ten central and peripheral countries from January 1999 to December 2012, we firstly examine the dynamic evolution of Granger-causality within the 90 pairs of yield spreads in our sample to detect episodes of contagion (associated with episodes of significant intensification in causality). Secondly, we make use of a logit model to explore whether there is evidence of "pure contagion" or "fundamentals-based contagion", by trying to determine which factors might have been behind the detected contagion episodes. Our results suggest that contagion episodes are concentrated just after the inception of the EMU and matching the Global Financial Crisis, yielding more accurate and sensible indicators than those obtained from DCC-GARCH models used in prior studies. Indeed, they preceded the outburst of the Global Financial Crisis (causality intensification is detected from March 2008), and reached a peak during January-May 2011. Furthermore, they underline the coexistence of "pure" and "fundamentals-based contagion" during the recent European debt crisis.