© 2009 International Monetary Fund WP/09/
IMF Working Paper
From Bear Stearns to Anglo Irish: How EurozoneSovereign Spreads Related to Financial Sector VulnerabilityPrepared by Ashoka Mody
This Working Paper should not be reported as representing the views of the IMF.
The views expressed in this Working Paper are those of the author(s) and do not necessarily representthose of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate.
This paper attempts to explain the recent rise and differentiation of sovereign spreads acrossthe countries of the eurozone. Following the onset of the subprime crisis in July 2007,spreads rose but mainly on account of common global factors. The rescue of Bear Stearns inMarch 2008 marked a turning point. Countries thereafter were increasingly differentiated.Sovereign spreads of a eurozone country tended to rise when the prospects of its domesticfinancial sector worsened. It appears, therefore, that the rescue of Bear Stearns created a link between financial sector vulnerabilities and a larger contingent liability on public finances.Following the failure of Lehman Brothers, spreads also rose faster for countries with higher ratios of public debt-to-GDP. These transitional dynamics appear to have concluded with thenationalization of Anglo Irish: sovereign spreads throughout the eurozone jumped, with the jump emphasizing the differentiation by financial sector vulnerability and public debt levels.The results imply that, to varying degrees, countries may have moved to a new regime of weak economic outlook, financial sector fragilities, and strains on public finances.JEL Classification Numbers: E62, G15, H63Author
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European Department, the International Monetary Fund. For helpful discussions, I am grateful to Abdul Abiad,Olivier Blanchard, Mark De Broeck, James Daniel, Erik De Vrijer, Peter Doyle, Juha Kähkönen, Philip Lane,Peter McGoldrick, Tom O’Connell, Jari Stehn, Axel Weber, and seminar participants at the IMF’s EuropeanDepartment. Susan Becker and Anastasia Guscina provided expert research assistance. The views expressed hereare those of the author and do not necessarily represent those of the IMF or its Executive Board.