Funding liquidity, credit risk and unconventional monetary policy in the Euro area: A GVAR approach (2111.01078v2)

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.