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Mr. Damiano Sandri and Mr. Ashoka Mody
We use the rise and dispersion of sovereign spreads to tell the story of the emergence and escalation of financial tensions within the eurozone. This process evolved through three stages. Following the onset of the Subprime crisis in July 2007, spreads rose but mainly due to common global factors. The rescue of Bear Stearns in March 2008 marked the start of a distinctively European banking crisis. During this key phase, sovereign spreads tended to rise with the growing demand for support by weakening domestic financial sectors, especially in countries with lower growth prospects and higher debt burdens. As the constraint of continued fiscal commitments became clearer, and coinciding with the nationalization of Anglo Irish in January 2009, the separation between the sovereign and the financial sector disappeared.
Ms. Edda Zoli and Ms. Silvia Sgherri
While the use of public resources is critical to cushion the impact of the financial crisis on the euro-area economy, it is key that the entailed fiscal costs not be seen by markets as undermining fiscal sustainability. From this perspective, to what extent do movements in euro area sovereign spreads reflect country-specific solvency concerns? In line with previous studies, the paper suggests that euro area sovereign risk premium differentials tend to comove over time and are mainly driven by a common time-varying factor, mimicking global risk repricing. Since October 2008, however, there is evidence that markets have become progressively more concerned about the potential fiscal implications of national financial sectors' frailty and future debt dynamics. The liquidity of sovereign bond markets still seems to play a significant (albeit fairly limited) role in explaining changes in euro area spreads.
Ms. Li L Ong and Mr. Martin Cihak
The paper examines the scope for cross-border spillovers among major EU banks using information contained in the stock prices and financial statements of these banks. The results suggest that spillovers within domestic banking systems generally remain more likely, but the number of significant cross-border links is already larger than the number of significant links among domestic banks, adding a piece of empirical evidence supporting the need for strong cross-border supervisory cooperation within the EU.
Mr. Chris Wright and Mr. John Joisce
When new international statistical standards were published in 1993, one of the major changes to the recommended presentation of the system of national accounts and the balance of payments was the adoption of accruals reporting for income and expenditure. However, as countries have begun to implement these standards, questions have arisen about their exact interpretation in respect of interest flows associated with tradable debt, where the cash flow is fixed at the time of issue but where the price of the instrument fluctuates with market conditions. A clear consensus has yet to emerge. The paper explores the issues involved in using the alternative approaches, the so-called "debtor" and "creditor" approaches. The debtor approach uses the rate implicit at the time of issue, and the creditor approach, the current market rate. The paper concludes that the creditor approach is the only one consistent with accrual principles and market valuation for the debt outstanding. It reviews implications for national and sectoral saving from this approach.
International Monetary Fund. Research Dept.
This paper highlights exchange rate movements and adjustment in financial markets. This paper develops a model of portfolio behavior in which it is assumed that market participants act as if they always expected exchange rates to move in line with expected inflation differentials. In the solution of this model, exchange rate movements are determined by real interest rate differentials and the cumulated balance of external payments. Two important empirical features distinguish this model from most other models based on the asset-market approach to exchange rate determination. The paper gives evidence that comparisons between these estimates and alternative models broadly support the model developed here. A principal conclusion is that interest rate differentials do have a clearer short-run relationship to exchange rate changes than to exchange rate levels.