Contagion and causality: an empirical analysis on sovereign bond spreads

The current decade was marked by the worst economic and financial crisis since the Great Depression, many economies experiencing a severe contraction of output in late 2008 and early 2009. But, was this evolution of the activity only the result of the domestic factors or a certain form of international contagion influenced it, at least partially? The aim of this paper is to empirically explore the contagion phenomenon during the subprime crisis for seven EU and non-EU countries. To test for contagion, we apply a Granger causality/VECM methodology on sovereign bond spreads as a measure of perceived country risk. Following partially the methodology of Kleimeier and Sander (2003), we investigate two sub-periods: a pre-crisis tranquil period (January, 1st 2003-July 29, 2007) and a crisis period (July 2, 2007 -September 1, 2009). Results highlight the fact that the causality patterns have changed during the crisis period compared to the pre-crisis tranquil period.