Evidence of severe financial contagion risk from weaker countries

New research shows unexpected evidence of severe financial contagion risk from weaker countries in European Union.

Extract from University of Portsmouth Press Release – 16 April 2013:

Financial shocks coming from weak Euro zone countries are three times more likely to destabilise the region’s economies than shocks from richer Euro zone countries, according to new research.

Research by Dr Nikolaos Antonakakis, an applied Economist at Portsmouth Business School, is among the first to find compelling – and unexpected – evidence of a severe financial contagion risk from weaker countries in the European Union.

The results challenge the arguments for a single European currency and suggest a need to re-examine the single currency in the new post-economic crisis era.

Dr Antonakakis said: “The findings highlight the increased vulnerability of the Euro zone from the destabilising shocks originating from beleaguered countries in the periphery.

“This is the first study to have found evidence of a financial contagion effect where what happens in weaker Euro zone countries spills over to the rest of the region. Most people assume the effect is the other way around. It is counter-intuitive and suggests there is probably a need to reassess the effectiveness of the EU directorate economic policies.”

Dr Antonakakis studied the difference between the 10-year government bond yields  of nine euro zone countries – Austria, Belgium, France, Netherlands, Greece, Ireland, Italy, Portugal and Spain – between March 2007 and June 2012; a turbulent period encompassing both the global financial crisis and the Euro zone debt crisis.

The data from the nine states was compared with German government bond yields of the same maturity over the same period and all data was collected from Bloomberg. The results provide information on whether each country is a receiver or a transmitter of economic shocks.

Dr Antonakakis said: “These results are of great importance because, for instance, changes in government bond yield spreads in other Euro zone countries can be a good indicator of future changes and their repercussions.

“Shocks coming from the periphery have, on average, three times the destabilising force on other countries than shocks coming from the core, richer nations. This indicates a decoupling effect of countries on the periphery and those at the core that may challenge the argument for a single currency in the countries examined.”

Until now, very little was known about the interdependencies and complex links between Euro zone economies during the debt crisis and global economic downturn.

He said: “The results have important policy implications and can be used to change for the better how governments and regions manage the balance of austerity measures and growth-promoting initiatives.

“The cost of severe austerity measures is not just economic, it has human lives at its heart. If we can produce models which can be used to predict the effect of different scenarios they could be used to help stave off some of the more barbaric measures used to contain economic problems.”

Dr Antonakakis, a senior lecturer in economics and finance, has been invited to present his research alongside world leaders in the field at the SIRE Econometrics Workshop in Glasgow in May. Fellow presenters include Cambridge Professor Hashem Pesaran, editor of Journal of Applied Econometrics, one of the top five econometric journals in the world; Professor Paolo Zaffaroni, Imperial College; Professor Valentina Corradi, Warwick; and Rod McCorie, St Andrews.

More … http://www.port.ac.uk/uopnews/2013/04/16/weak-european-neighbours-have-immense-power/