Funding liquidity, credit risk and unconventional monetary policy in the Euro area: A GVAR approach

TL;DR

This study uses a GVAR model to analyze how funding liquidity, credit risk, and unconventional monetary policy interact in the Euro area, revealing heterogeneous effects and spillovers among countries from 2006 to 2017.

Contribution

It introduces a financial GVAR approach to jointly analyze liquidity, credit risk, and monetary policy impacts across multiple Euro area countries.

Findings

Marginally significant core-periphery heterogeneity observed.

Flight-to-quality effects identified in response to shocks.

ECB program reductions increase bond yields and CDS spreads, especially in Italy and Spain.

Abstract

This paper investigates the transmission of funding liquidity shocks, credit risk shocks and unconventional monetary policy within the Euro area. To this aim, we estimate a financial GVAR model for Germany, France, Italy and Spain on monthly data over the period 2006-2017. The interactions between repo markets, sovereign bonds and banks' CDS spreads are analyzed, explicitly accounting for the country-specific effects of the ECB's asset purchase programmes. Impulse response analysis signals marginally significant core-periphery heterogeneity, flight-to-quality effects and spillovers between liquidity conditions and credit risk. Simulated reductions in ECB programmes tend to result in higher government bond yields and bank CDS spreads, especially for Italy and Spain, as well as in falling repo trade volumes and rising repo rates across the Euro area. However, only a few responses to shocks achieve statistical significance.