Measuring sovereign contagion in Europe

This paper analyzes sovereign risk shift-contagion, i.e. positive and significant changes in the propagation mechanisms, using bond yield spreads for the major eurozone countries. By emphasizing the use oftwo econometric approaches based on quantile regressions (standard quantile regression and Bayesianquantile regression with heteroskedasticity) we find that the propagation of shocks in euro\u2019s bond yieldspreads shows almost no presence of shift-contagion in the sample periods considered (2003\u20132006,Nov. 2008\u2013Nov. 2011, Dec. 2011\u2013Apr. 2013). Shock transmission is no different on days with big spreadchanges and small changes. This is the case even though a significant number of the countries in our sample have been extremely affected by their sovereign debt and fiscal situations. The risk spillover amongthese countries is not affected by the size or sign of the shock, implying that so far contagion has remainedsubdued. However, the US crisis does generate a change in the intensity of the propagation of shocks inthe eurozone between the 2003\u20132006 pre-crisis period and the Nov. 2008\u2013Nov. 2011 post-Lehman one,but the coefficients actually go down, not up! All the increases in correlation we have witnessed overthe last years come from larger shocks and the heteroskedasticity in the data, not from similar shockspropagated with higher intensity across Europe. These surprising, but robust, results emerge becausethis is the first paper, to our knowledge, in which a Bayesian quantile regression approach allowing forheteroskedasticity is used to measure contagion. This methodology is particularly well-suited to dealwith nonlinear and unstable transmission mechanisms especially when asymmetric responses to signand size are suspected