Working Paper: NBER ID: w27451
Authors: Yothin Jinjarak; Rashad Ahmed; Sameer Nair; Weining Xin; Joshua Aizenman
Abstract: We compare the importance of market factors against that of COVID-19 dynamics and policy responses in explaining Eurozone sovereign spreads. First, we estimate a multifactor model for changes in credit default swap (CDS) spreads over January 2014 - June 2019. Then, we apply a synthetic control-type procedure to extrapolate model-implied changes in the CDS. The factor model does very well over the rest of 2019 but breaks down during the pandemic, especially during March 2020 when there is a large divergence between the actual and model-implied CDS changes. We find that the March 2020 divergence is well accounted for by COVID-specific risks and associated policies, mortality outcomes, and policy announcements, rather than traditional determinants. Daily CDS widening ceased almost immediately after the ECB announced the PEPP, but the divergence between actual and model-implied changes persisted. This points to COVID-19 Dominance: widening spreads during the pandemic has led to unconventional monetary policies that primarily aim to mitigate short-run fears, temporarily pushing away concerns over fiscal risk.
Keywords: COVID-19; Eurozone; Sovereign Spreads; Fiscal Policy; Monetary Policy
JEL Codes: F3; F34; F41; F45; H12; H5; H51
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| COVID-related mortality rates (J17) | CDS spread dynamics (C69) |
| Policy announcements (E60) | CDS spread dynamics (C69) |
| Pandemic Emergency Purchase Programme (PEPP) announcement (E60) | CDS widening cessation (C42) |
| Traditional determinants of CDS spreads (E43) | COVID-specific risks (H12) |
| COVID-specific risks (H12) | CDS residual (G19) |
| Mortality outcomes (I12) | COVID residual (C59) |