Abstract

DID THE ABSENCE OF A CENTRAL BANK BACKSTOP IN THE SOVEREIGN BOND MARKETS EXACERBATE SPILLOVERS DURING THE EURO-AREA CRISIS?

 

Heather D. Gibson
Bank of Greece

Stephen G. Hall
University of Leicester, Bank of Greece and University of Pretoria

Deborah Gefang
University of Leicester

Pavlos Petroulas
Bank of Greece

George S. Tavlas
Bank of Greece and Hoover Institution, Stanford University


ABSTRACT

The euro-area sovereign debt crisis was characterized by feedback loops between (1) sovereign bond ratings and sovereign spreads in single jurisdictions and (2) sovereign spreads and ratings among jurisdictions. One explanation of this circumstance is that the ECB was unable to perform the role of lender of last resort in the sovereign bond markets during the crisis. We provide a spatial framework that allows us to distinguish among European countries whose central banks were permitted to function as lender of last resort in those markets and countries whose central banks were not permitted to do so. Our results are consistent with the view that the absence of a central bank backstop in the sovereign bond markets exacerbated feedback loops. 



Keywords: euro-area crisis, simultaneous spatial model, European banks, spreads, sovereign ratings

JEL-Classification: E3, G01, G14, G21

Acknowledgement: We are grateful to Xiaodong Liu for making the Monte Carlo Matlab code available to us from his paper Liu and Saraiva (2019).

Correspondence: 
George S. Tavlas
Bank of Greece
21 E Venizelos Ave
Athens, 10250, Greece
Tel. no. +30 210 320 2370
Fax. no. +30 210 320 2432
Email:gtavlas@bankofgreece.gr

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