From Bear Stearns to Anglo Irish: How Eurozone Sovereign Spreads Related to Financial Sector Vulnerability by Ashoka Mody

Author:Ashoka Mody
Language: eng
Format: epub
ISBN: 9781451986259
Publisher: International Monetary Fund
Published: 2009-08-15T00:00:00+00:00

Table 5. Explaining the Jump in Spreads After the Anglo Irish Nationalization

z-statistics in parentheses, *** p < 0.01, ** p < 0.05, * p < 0.1

The results in Table 5 confirm this presumption. As column 1 shows, spreads tended to rise everywhere (the post-Anglo Irish dummy is positive and significant) but the rise in spreads was greater for countries with a lower F-index (the interaction term is negative and significant). That this was not driven by the extreme Irish developments is confirmed in column 2 where the finding holds even if Ireland is not included in the regression.

Column 3 explores the possibility that countries were also differentiated by their debt levels.10 And there seems some reason to think that that was the case. The interaction term is positive, implying that in those two weeks, countries with higher public debt experienced, all else equal, more rapid increase in spreads. This is more evident when Finland, which has a very high F-index, is also dropped from the sample. It is the case that the interaction of the post-Anglo Irish dummy and the debt-to-GDP ratios is not significant at the customary 5 percent level. However, all that says is that countries with relatively low levels of debt were not necessarily differentiated; with higher debt levels, both the size of the post-Anglo Irish effect and its statistical significance are larger.

Thus, in the last two weeks of January, an ongoing process was accelerated. While in the period leading up to mid-January, changes in financial vulnerability were followed by a rise in spreads, in the final weeks of January, spreads responded to the level of vulnerability. Markets evidently decided that they had some catching up to do. And that catch up had a tangible goal in some countries. For the most part, spreads on banks’ own debt had been higher than on sovereign spreads from the start of the subprime crisis. This was true for much of the period and for most countries. Only in Italy and Portugal, bank and sovereign spreads had converged, with sovereign spreads actually rising above bank spreads sometime after the fall of Lehman Brothers. The last two weeks of January saw a wider convergence of spreads: even as sovereign spreads rose, bank spreads fell as if the sovereign had taken on the risk of the financial sector. After those two dramatic weeks, bank spreads have once again typically been higher than sovereign spreads. However, the significance of the last two weeks of January appears to be that sovereign and bank risks caught up with each other and have tended thereafter to exhibit more comovement rather than the lagged relationship observed in the previous months.

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