Overview of the special issue on financial stress in the eurozone

Journal of International Money and Finance 31 (2012) 465–468 Contents lists available at SciVerse ScienceDirect Journal of International Money and Finance journal homepage: www.elsevier.com/locate/jimf Guest Editorial Overview of the special issue on financial stress in the eurozone 1. Introduction The Department of Economics of the University of Crete has been organizing the annual International Conference on Macroeconomic Analysis and International Finance since 1997. The articles included in this special issue are refereed versions of papers presented at the 15th International Conference on Macroeconomic Analysis and International Finance held at the University Campus, Rethymno from 26 to28 May 2011 in collaboration with JIMF. The central theme of this conference was Financial Stress in the Eurozone. This issue has attracted extensive attention both in academic and general-public circles during the current period of financial turmoil. Recent advances on research on the eurozone debt crisis have focused on three important policy-oriented topics: financial and sovereign-debt crises, liquidity and credit risk during the financial crisis and sovereign bond yields and default risk. We open this issue with an overview of the papers dealing with these issues. 2. Financial and sovereign debt crises In his keynote lecture “Financial Flows, Financial Crises, and Global Imbalances” Maurice Obstfeld documents the proliferation of gross international asset and liability positions and discusses some of the consequences for individual countries’ external adjustment processes and for global financial stability. In light of the rapid growth of gross global financial flows and the serious risks associated with them, one might wonder about the continuing relevance of the net financial flow measured by the current account balance. Obstfeld argues that global current account imbalances remain an essential target for policy scrutiny, for financial as well as macroeconomic reasons. Nonetheless, it is critically important for policymakers to monitor as well the rapidly evolving structure of global assets and liabilities. Anne-Laure Delatte, Mathieu Gex and Antonia Lopez-Villavicencio, in “Has the CDS market influenced the borrowing cost of the European countries during the sovereign crisis?” evaluate the potential influence of the growing CDS market on the borrowing cost of sovereign states during the European sovereign crisis. They analyze the sovereign debt market to ascertain the pattern of information transmission between the CDS and corresponding bond markets. They conduct their analysis using a non-linear panel smooth transition model rather than the standard linear VECM specification. They employ data for the financial crisis period of 2008-2010. They report three main findings. First, linearity tests show that the null hypothesis of a linear transmission mechanism between the bond and the CDS markets can be clearly rejected. Second, market distress alters the mutual influence exercised by each market. Third, the higher the level of distress the more the CDS market dominates information transmission between CDS and bond markets. 0261-5606/$ – see front matter Ó 2011 Elsevier Ltd. All rights reserved. doi:10.1016/j.jimonfin.2011.11.016 466 Guest Editorial / Journal of International Money and Finance 31 (2012) 465–468 In the first part of their paper “The Greek financial crisis: growing imbalances and sovereign spreads”, Heather Gibson, Stephen Hall and George Tavlas, conduct a thorough investigation of the origins of the Greek financial crisis as manifested in the growing fiscal and current-account deficits since euro-area entry in 2001. In the second part of their analysis the authors extend a model typically used to explain risk premia to assess the extent to which credit ratings capture these premia. They then estimate a cointegrating relationship between bond spreads and their long-term fundamental determinants and compare the spreads predicted by the model with the actual spreads. The main finding of their analysis is that actual spreads were substantially below what would be predicted by fundamentals from the end of 2004 to the middle of 2005 and from then on substantially above model predictions, exceeding model predictions over this period by some 400 basis points. Theoharry Grammatikos and Robert Vermeulen, in “Transmission of the Financial and Sovereign Debt Crises to the EMU: Stock Prices, CDS Spreads and Exchange Rates” focus on testing for the transmission of the 2007-2010 financial and sovereign debt crises to fifteen EMU countries. They use daily data from 2003 to 2010 on country financial and non-financial stock market indices to analyze the stock market returns for three country groups within the EMU: North, South and Small. There are several results obtained from the analysis which hold for both the North and South European countries, while the smallest countries seem to be relatively isolated from international events. First, they find strong evidence of crisis transmission to European non-financials from US non-financials, but not for financials. Second, in order to test how the sovereign debt crisis affects stock market developments they split the crisis in a pre- and post-Lehman sub period. Results show that financials become significantly more dependent on changes in the difference between the Greek and German CDS spreads after Lehman’s collapse, compared to the pre-Lehman sub period. However, this increase is much smaller for non-financials. Third, before the crisis, euro appreciations coincide with European stock market decreases while during the crisis this relationship reverses. Finally, this reversal seems to be triggered by events surrounding Lehman’s collapse. 3. Liquidity and credit risk during the financial crisis In “The EONIA Spread Before and During the Crisis of 2007 to 2009: The Role of Liquidity and Credit Risk”. John Beirne provides an empirical assessment of the factors affecting the spread between the euro area overnight interest rate (EONIA) and the main policy rate of the European Central Bank (ECB). It is shown that up until the period when Lehman Brothers collapsed in mid-September 2008, the spread was small and positive. Following the collapse, the liquidity surplus that developed from the fixed rate full allotment tendering arrangement in refinancing operations drove the widening of the EONIA spread (trading below the ECB policy rate), although other factors also played a significant role. Their study, therefore, helps explains the forces driving the spread across alternative non-crisis and crisis regimes. In addition, the paper examines how the EONIA spread reacts to shocks imposed on a range of liquidity and credit-risk factors in the alternative regimes. Stefan Eichler and Kai Hielscher, in “Does the ECB Act as a Lender of Last Resort During the Subprime Lending Crisis?: Evidence from a Regime Switching Taylor Rule Model,” investigate whether the ECB aligns its monetary policy with financial-crisis risk in the EMU member countries. They find that since the outbreak of the subprime crisis the ECB has significantly increased net lending and reduced interest rates when banking- and sovereign-debt crisis risk in vulnerable EMU periphery countries (Greece, Ireland, Italy, Portugal, and Spain) increases, but find no significant effect for the pre-crisis period or the relatively tranquil EMU countries (Austria, Belgium, France, Germany, and the Netherlands). These findings are consistent with the hypothesis that the ECB has acted as a lender of last resort for vulnerable EMU countries in order to prevent withdrawals from the EMU. In “Loan Supply Shocks During the Financial Crisis: Evidence for the Euro Area”, Nikolay Hristov, Oliver Hulsewigz and Timo Wollmershauser, employ a panel vector autoregressive model for the member countries of the Euro Area to explore the role of banks during the slump of the real economy that followed the financial crisis. In particular, they seek to quantify the macroeconomic effects of adverse loan-supply shocks, which they identify using sign restrictions. Their analysis leads to the conclusion that loan-supply shocks significantly contributed to the evolution of the loan volume and real GDP growth in all member countries during the financial crisis. This finding provides further Guest Editorial / Journal of International Money and Finance 31 (2012) 465–468 467 evidence that the Euro Area is characterized by a considerable degree of cross–country heterogeneity, which is reflected both in the timing and the magnitude of the shocks. In some countries – like Austria, Finland and Italy – the adverse effects of loan-supply shocks were particularly strong in 2008, while in other countries – like Germany, Spain and France – they only emerged strongly during the course of 2009 and 2010. Sebastien Walti, in “Why has trust in the European Central Bank fallen so much during the crisis?”, investigates the argument that public trust in economic institutions has generally declined since the onset of the crisis. In particular, Eurobarometer surveys show that trust in the European Central Bank has fallen significantly during the crisis. Therefore, Walti studies the determinants of public trust in the ECB, especially during the crisis. Net trust in the ECB has decreased significantly in those countries which have experienced increasing sovereign bond yields and financial market turbulence. The finding that country-specific variables affect citizens’ trust in the ECB may seem counterintuitive. However, it is consistent with widespread evidence in the political science literature showing that domestic considerations play a significant role when citizens get an opportunity to express their opinion on EU matters. 4. Sovereign bond yields and default risk Antonio Afonso, Davide Furceri and Pedro Gomes, in “Sovereign credit ratings and financial markets linkages: application to European data” employ EU sovereign bond yield and CDS spreads daily data to carry out an event study of the reaction of government yield spreads before and after announcements from rating agencies (Standard & Poor’s, Moody’s, Fitch). The results of their analysis show significant responses of government bond yield spreads to changes in rating notations and outlook, particularly in the case of negative announcements. First, announcements are not anticipated at horizons of 1–2 months but there is bi-directional causality between ratings and spreads within1-2 weeks. Second, spill over effects exist especially among EMU countries and from lower rated countries to higher rated countries. Finally, persistence effects are present for recently downgraded countries. In “Sovereign bond yield spreads: A time-varying coefficient approach” Kerstin Bernoth and Burcu Erdogan study the determinants of sovereign bond yield spreads across 10 EMU countries between Q1/1999 and Q1/2010. The analysis is done with the application of a semi parametric time-varying coefficient model to identify, to what extent an observed change in the yield spread is due to a shift in macroeconomic fundamentals as opposed to altering risk pricing. They find that at the beginning of EMU, the government debt level and the general investors’ risk aversion had a significant impact on interest differentials. In the subsequent years, however, financial markets paid less attention to the fiscal position of a country and the safe haven status of Germany diminished in importance. By the end of 2006, two years before the collapse of Lehman Brothers, financial markets began to grant Germany safe haven status again. One year later, when financial turmoil began, the market reaction to fiscal loosening increased considerably. Dominik Maltritz, in “Determinants of Sovereign Yield Spreads in the Eurozone: A Bayesian Approach” analyzes the determinants of sovereign yields spreads of EMU member states applying Bayesian Model Averaging (BMA) to annual panel data from 1999-2009. BMA is well-suited in cases of small samples and high model uncertainty. This seems to be the case in modeling sovereign yield spreads in the Eurozone since the literature reports heterogeneous results with respect to explanatory variables. The analysis focuses on testing a number of variables reported to be significant in the literature and find that the most likely country-specific drivers of yield spreads are fiscal variables such as budget balance and government debt, as well as external sector variables, such as terms of trade, trade balance and openness. Global financing conditions, proxied by the US interest rate, and market sentiments, proxied by corporate bond spreads, are likely to influence sovereign yield spreads. 5. Conclusions The crucial issue of financial stress in the eurozone is addressed in the present special issue of JIMF through a spectrum of approaches, including the investigation on the causes and implications of global macroeconomic imbalances on the current financial crisis, the role of the ECB and loan supply during 468 Guest Editorial / Journal of International Money and Finance 31 (2012) 465–468 the financial crisis and the determinants of default risk and estimation of bond spread yields. Important policy implications for the above areas are drawn from the papers in this Special Issue. Acknowledgements We wish to thank the discussants, referees and all participants at the Conference whose comments have improved substantially the papers presented in this volume. We are also grateful to the University of Crete, Bank of Greece and EFG Eurobank for their generous financial support. Last but not least we would like to thank Ms. Ioanna Yotopoulou for her superb secretarial assistance as well as Mr. Pericles Drakos and Mr. Kostis Pigounakis for their technical support. Georgios P. Kouretas* Department of Business Administration, Athens University of Economics and Business, GR-14034 Athens, Greece Athanasios P. Papadopoulos Department of Economics, University of Crete, University Campus, GR-74100 Rethymno, Greece E-mail address: appapa@econ.soc.uoc.gr  Corresponding author. Tel.: þ30 2108203277; fax: þ30 2108226203. E-mail address: kouretas@aueb.gr