23 February 2012

De Haan/Mink: Contagion during the Greek sovereign debt crisis

This column argues that news about Greek public finances does not affect eurozone bank stock prices, while news about a Greek bailout does. This suggests that markets consider news about a Greek bailout to be a signal of eurozone countries' willingness to use public funds to combat the financial crisis.

There is, as yet, surprisingly limited research on contagion in the current eurozone debt crisis. De Haan/Mink contribute to this literature in a recent paper (Mink and de Haan 2012), performing an event study to analyse the impact of news about Greece and about a Greek bailout on prices of European bank stocks and sovereign bonds. As an innovation to the standard approach, they identify the events as the trading days in 2010 with the largest fluctuations in the price of Greek government bonds, and relate those days to the ‘news’ that caused these fluctuations. This way, they circumvent a major problem of event studies, namely how to identify event days during which there is really an event that is not expected (and therefore not priced in). The news reports, taken from Reuters, were classified into two categories, i.e. news about Greek public finances and news about the willingness (or lack thereof) of European countries to provide financial support to Greece. This way, the authors distinguish between market reactions due to fears of contagion from a Greek default and reactions reflecting moral hazard caused by the prospect of a sovereign bailout.

Using data for 48 listed banks included in the 2010 European stress test, de Haan/Mink's findings indicate that only news about the Greek bailout has a significant effect on bank stock prices, even on stock prices of banks without any exposure to Greece or other highly indebted eurozone countries. News about the economic situation in Greece does not lead to abnormal stock price returns. However, de Haan/Mink also find that the price of sovereign debt of Portugal, Ireland and Spain responds to both news about Greece and news about a Greek bailout. Still, the finding that news about the economic situation in Greece affects sovereign bond prices of other highly-indebted eurozone countries does not necessarily imply contagion, as it is also in line with the ‘wake-up call’ view. According to this view, a crisis initially restricted to one country may provide new information prompting investors to reassess the vulnerability of other countries, which spreads the crisis across borders.

De Haan/Mink's results suggest that financial markets’ response to developments in the Greek sovereign debt crisis should not too easily be attributed to contagion, but can also be due to moral hazard and learning effects. The finding that also banks without a direct exposure on Greek sovereign debt benefit from a Greek bailout, illustrates the size of the moral hazard that results from such rescue operations. While hard to avoid in the midst of a financial crisis, preventative measures such as strict financial regulation are needed to keep market players from anticipating rescue operations even in good times. De Haan/Mink's finding – that learning effects can play an important role in the simultaneous interest rate increases across Eurozone countries – illustrates that these joint increases are not necessarily inconsistent with efficient price formation in financial markets.

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