Market sentiments and the sovereign debt crisis in the Eurozone

Arbeitspapier

In this paper we test two theories of the determination of the government bond spreads in a monetary union. The first one is based on the efficient market theory. According to this theory, the surging spreads observed from 2010 to the middle of 2012 were the result of deteriorating fundamentals (e.g. domestic government debt, external debt, competitiveness, etc.). The second theory recognizes that collective movements of fear and panic can have dramatic effects on spreads. These movements can drive the spreads away from underlying fundamentals, very much like in the stock markets prices can be gripped by a bubble pushing them far away from underlying fundamentals. The implication of that theory is that while fundamentals cannot be ignored, there is a special role for the central bank that has to provide liquidity in times of market panic, so as to avoid that countries are pushed into a bad equilibrium. We tested these theories and concluded that there is strong evidence for the second theory. The policy implications are that the role of the ECB as lender of last resort in the government bond markets is an important one. The recent attempts by the German Constitutional Court risk undermining this role and by the same token the stability of the Eurozone.

Object Details

• Language: Englisch

References and Relationships

• Bibliographic citation: Series: FinMaP-Working Paper ; No. 28

Classification and Topics

• Classification: Wirtschaft

Contributors, Places and Time

• Event: Geistige Schöpfung
• (who): de Grauwe, Paul ; Ji, Yuemei
• Event: Veröffentlichung
• (who): Kiel University, FinMaP - Financial Distortions and Macroeconomic Performance
• (where): Kiel
• (when): 2015

Further information

• Handle: http://hdl.handle.net/10419/106210
• Last update: 10.03.2025, 11:45 AM CET