print Share page with AddThis

Working papers


Liquidity and tail-risk interdependencies in the euro area sovereign bond market

Download PDF: Working Paper 41

This paper shows that liquidity linkages in European sovereign bond markets can amplify fundamental economic shocks.

Authors: Daragh Clancy (ESM), Peter G. Dunne (Central Bank of Ireland), Pasquale Filiani (Central Bank of Ireland)

This paper was awarded the prize for “best paper in the area of fixed income markets and infrastructure investment” by the European Capital Markets Institute



The likelihood of severe contractions in an asset's liquidity can feed back to the ex-ante risks faced by the individual providers of such liquidity. These self-reinforcing effects can spread to other assets through informational externalities and hedging relations. We explore whether such interdependencies play a role in amplifying tensions in European sovereign bond markets and are a source of cross-market spillovers. Using high-frequency data from the inter-dealer market, we find significant own- and cross-market effects that amplify liquidity contractions in the Italian and Spanish bond markets during times of heightened risk. The German Bund's safe-haven status exacerbates these amplification effects. We provide evidence of a post-crisis dampening of cross-market effects following crisis-era changes to euro area policies and institutional architecture. We identify a structural break in Italy's cross-market conditional correlation during rising political tensions in 2018, which significantly reduced liquidity. Overall, our findings demonstrate potential for the provision of liquidity across sovereign markets to be vulnerable to sudden fractures, with possible implications for euro area economic and financial stability.

Disclaimer: This Working Paper should not be reported as representing the views of the ESM. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the ESM or ESM policy. No responsibility or liability is accepted by the ESM in relation to the accuracy or completeness of the information, including any data sets, presented in this Working Paper.

Keywords: Liquidity; Tail risks; Feedback loops; Spillovers

JEL codes: G01, G15, F36

Source: European Stability Mechanism | Working Paper Series | Volume 2019 | No 41 | November 2019 | 57 Pages

Copyright © European Stability Mechanism, 2019 | All rights reserved. Any reproduction, publication and reprint in the form of a different publication, whether printed or produced electronically, in whole or in part, is permitted only with the explicit written authorisation of the European Stability Mechanism.

Further information and related content

Section for US QIB Investors Subscribe to ESM News