The Euro Area Sovereign Debt Crisis: Can Contagion Spread from the Periphery to the Core?

Abstract

We examine the determinants of joint default risk of Euro Area countries during 2007-2011. To accomplish this, we recover joint default probabilities from individual CDS contracts. In contrast to earlier theoretical studies, we find that financial linkages are an active contagion transmission channel only in the case of the troubled periphery Euro Area economies. During the current sovereign debt crisis, real economy linkages play a more important role in transmitting shocks from the Euro Area periphery towards its core. Countries that have stronger trade interconnections with troubled economies tend to have a higher expected joint default risk.

Keywords: Sovereign Debt, Tail Risk, Contagion

JEL Classification: G01, G15