Large exporters are simultaneously large importers. In this paper, we show that this pattern is key to understanding low aggregate exchange rate pass-through as well as the variation in pass-through across exporters. First, we develop a theoretical framework that combines variable markups due to strategic complementarities and endogenous choice to import intermediate inputs. The model predicts that fi rms with high import shares and high market shares have low exchange rate pass-through. Second, we test and quantify the theoretical mechanisms using Belgian fi rm-product-level data with information on exports by destination and imports by source country. We confi rm that import intensity and market share are the prime determinants of pass-through in the cross-section of fi rms. A small exporter with no imported inputs has a nearly complete pass-through of over 90 percent, while a fi rm at the 95th percentile of both import intensity and market share distributions has a pass-through of 56 percent, with the marginal cost and markup channels playing roughly equal roles. The largest exporters are simultaneously highmarket-share and high-import-intensity fi rms, which helps explain the low aggregate pass-through and exchange rate disconnect observed in the data.

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Importers, Exporters, and Exchange Rate Disconnect

In this paper we modify and extend the framework of Diebold and Yilmaz (2011) to quantify spillovers between sovereign credit markets and banks in the euro area. Spillovers are estimated recursively from a vector autoregressive model of daily changes in credit default swap (CDS) spreads with exogenous common factors. We account for interdependencies between sovereign and bank CDS spreads and derive generalized impulse response functions. Specifically, we assess the systemic effect of an unexpected shock to the creditworthiness of a sovereign or country-specific bank index on other sovereigns and bank CDSs between October 2009 and July 2012. Channels of shock transmission from or to sovereigns and banks are summarized in a Contagion Index and its four components: (i) among sovereigns, (ii) among banks, (iii) from sovereigns to banks, and (iv) from banks to sovereigns. We also highlight the impact of policy-related events on the Contagion Index.

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The dynamics of spillover effects during the European sovereign debt turmoil

Systemic risk in European sovereign debt markets: A CoVaR-copula approach

Credit default swaps (CDS) have been growing in importance in the global financial markets. However, their role has been hotly debated, in industry and academia, particularly since the credit crisis of 2007-2009. We review the extant literature on CDS that has accumulated over the past two decades. We divide our survey into seven topics after providing a broad overview in the introduction. The second section traces the historical development of CDS markets and provides an introduction to CDS contract definitions and conventions. The third section discusses the pricing of CDS, from the perspective of no-arbitrage principles, structural, and reduced-form credit risk models. It also summarizes the literature on the determinants of CDS spreads, with a focus on the role of fundamental credit risk factors, liquidity and counterparty risk. The fourth section discusses how the development of the CDS market has affected the characteristics of the bond and equity markets, with an emphasis on market efficiency, price discovery, information flow, and liquidity. Attention is also paid to the CDS-bond basis, the wedge between the pricing of the CDS and its reference bond, and the mispricing between the CDS and the equity market. The fifth section examines the effect of CDS trading on firms' credit and bankruptcy risk, and how it affects corporate financial policy, including bond issuance, capital structure, liquidity management, and corporate governance. The sixth section analyzes how CDS impact the economic incentives of financial intermediaries. The seventh section reviews the growing literature on sovereign CDS and highlights the major differences between the sovereign and corporate CDS markets. In the eight section, we discuss CDS indices, especially the role of synthetic CDS index products backed by residential mortgage-backed securities during the financial crisis.We close with our suggestions for promising future research directions on CDS contracts and markets.

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Credit Default Swaps: A Survey

Announcements of ECB unconventional programs: Implications for the sovereign spreads of stressed euro area countries

This paper investigates contagion between bank risk and sovereign risk in Europe over the period 2006-2011. Since this period covers various stages of the banking and sovereign crisis, it oers a fertile ground to analyze bank/sovereign risk spillovers. We de…ne contagion as excess correlation, i.e. correlation between banks and sovereigns over and above what is explained by common factors, using CDS spreads at the bank and at the sovereign level. Moreover, we investigate the determinants of contagion by analyzing bank-speci…c as well as country-speci…c variables and their interaction. We provide empirical evidence that various contagion channels are at work, including a strong home bias in bank bond portfolios, using the EBA's disclosure of sovereign exposures of banks. We …nd that banks with a weak capital and/or funding position are particularly vulnerable to risk spillovers. At the country level, the debt ratio is the most important driver of contagion.

/pdf/bank-sovereign-risk-spillovers-in-the-european-debt-crisis-50pl97nro3.pdf

Bank/sovereign risk spillovers in the European debt crisis ☆

This paper investigates contagion between bank risk and sovereign risk in Europe over the period 2006-2011. Since this period covers various stages of the banking and sovereign crisis, it offers a fertile ground to analyze bank/sovereign risk spillovers. We define contagion as excess correlation, i.e. correlation between banks and sovereigns over and above what is explained by common factors, using CDS spreads at the bank and at the sovereign level. Moreover, we investigate the determinants of contagion by analyzing bank-specific as well as country-specific variables and their interaction. We provide empirical evidence that various contagion channels are at work, including a strong home bias in bank bond portfolios, using the EBA's disclosure of sovereign exposures of banks. We find that banks with a weak capital and/or funding position are particularly vulnerable to risk spillovers. At the country level, the debt ratio is the most important driver of contagion.

/pdf/bank-sovereign-risk-spillovers-in-the-european-debt-crisis-181a5d64vd.pdf

Bank/Sovereign Risk Spillovers in the European Debt Crisis

Bank bailouts in Europe and bank performance

Current deposit insurance arrangements in Europe need to be changed, as they match neither market integration nor consumer expectations. But deposit insurance cannot be considered in isolation; it is part of the broader financial safety net and the crisis resolution tools for banks. Confronted with the question of what option should be taken to draw the right lessons from the crisis, practically the only option is an EUwide fund, but policy-makers are still hesitant. Any intermediate solution will maintain too many distortions and imperfections and will not provide a coherent response to current challenges. This policy brief starts with a review of current policy discussions on deposit insurance in the EU. 1 The second part looks at the role of deposit insurance as part of the (European) financial safety net. The following sections examine the Commission’s recent proposal to amend the EU Directive on deposit guarantee schemes (DGS), and what is missing from it. The three options for a European deposit guarantee scheme and their implications are assessed in the fifth part. The final section presents conclusions and recommendations.

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Options for reforming deposit protection schemes in the EU

With the financial crisis, citizens suddenly realized that different levels and forms of depositor protection co-existed in the EU, whereas they had been told for almost 20 years that a single market was in place. Current deposit insurance arrangements in Europe need to be changed, as they match neither market integration nor consumer expectations. But deposit insurance cannot be considered in isolation; it is part of the broader financial safety net and the crisis resolution tools for banks. Confronted with the question of what action should be taken to draw the right lessons from the crisis, practically the only option is an EU-wide fund, but policy-makers are still hesitant. Any intermediate solution will maintain too many distortions and imperfections and will not provide a coherent response to current challenges. This policy brief reviews current policy discussions on deposit insurance in the EU. It looks at the role of deposit insurance as part of the (European) financial safety net and examines the Commission’s recent proposal to amend the EU Directive on deposit guarantee schemes (DGS). The three options for a European DGS are assessed, followed by conclusions and recommendations.

Maria Gerhardt

Papers

Bank/sovereign risk spillovers in the European debt crisis ☆

Bank/Sovereign Risk Spillovers in the European Debt Crisis

Bank bailouts in Europe and bank performance

Options for reforming deposit protection schemes in the EU

Options for reforming deposit protection schemes in the EU