Empirical Investigation of Systemic Risk in the New EU States

Sovereign CDS spreads have become major variables focused on risks and expectations about the fiscal situation of different countries. In the paper we investigate, first, whether there is a link in the new member states between the expectations about the condition of their public finances and the dynamics of money markets, including integration of national money markets with the Euro area. Second, we look on the particularities of this relationship through the different phases of the crisis and across the different countries using different monetary regimes. This concerns mostly two opposite extreme monetary regimes, namely, currency boards (and quasi-fixed exchange rate) - Bulgaria, Estonia, Latvia, Lithuania, or inflation targeting - Poland, Czech Republic, Hungary and Romania. The results obtained form the high frequency panel data models support the theoretical hypotheses and policy intuition that exists strong relationship between the liquidity risk (measured by the short term money markets) and fiscal risk (measured by CDS) and that this link is extremely unstable and in some sense nonlinear during the financial crisis. Our study confirm that the strong link between monetary and public finance risk as apart of total systemic risk increase during the crisis especially for currency boards regimes, when the link becomes stronger and pronounced. For the inflation targeting countries the link became weaker and less pronounced.