Sovereign Spreads: Global Risk Aversion, Contagion or Fundamentals?

30 Pages Posted: 13 May 2010

See all articles by Carlos Caceres

Carlos Caceres

International Monetary Fund (IMF)

Vincenzo Guzzo

International Monetary Fund (IMF)

Miguel Segoviano

London School of Economics & Political Science (LSE) - Financial Markets Group

Multiple version iconThere are 2 versions of this paper

Date Written: May 11, 2010

Abstract

Over the past year, euro area sovereign spreads have exhibited an unprecedented degree of volatility. This paper explores how much of these large movements reflected shifts in (i) global risk aversion (ii) country-specific risks, directly from worsening fundamentals, or indirectly from spillovers originating in other sovereigns. The analysis shows that earlier in the crisis, the surge in global risk aversion was a significant factor influencing sovereign spreads, while recently country-specific factors have started playing a more important role. The perceived source of contagion itself has changed: previously, it could be found among those sovereigns hit hard by the financial crisis, such as Austria, the Netherlands, and Ireland, whereas lately the countries putting pressure on euro area government bonds have been primarily Greece, Portugal, and Spain, as the emphasis has shifted towards short-term refinancing risk and long-term fiscal sustainability. The paper concludes that debt sustainability and appropriate management of sovereign balance sheets are necessary conditions for preventing sovereign risk from feeding back into broader financial stability concerns.

Keywords: Sovereign spreads, contagion, market price of risk, fiscal policy

JEL Classification: E43, E44, G01, G10

Suggested Citation

Caceres, Carlos and Guzzo, Vincenzo and Segoviano, Miguel, Sovereign Spreads: Global Risk Aversion, Contagion or Fundamentals? (May 11, 2010). IMF Working Paper No. 10/120, Available at SSRN: https://ssrn.com/abstract=1607037

Carlos Caceres (Contact Author)

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

Vincenzo Guzzo

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

Miguel Segoviano

London School of Economics & Political Science (LSE) - Financial Markets Group ( email )

Houghton Street
London WC2A 2AE
United Kingdom

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