Measuring Contagion in the European Sovereign Bond Market

I propose a simple econometric model to capture the interaction between commonness and idiosyncrasy in returns on sovereign bonds of Eurozone countries. Common contagion is defined as the impact of yesterday's idiosyncratic shocks on today's common factor. When assuming returns are driven by one common factor, the model shows the presence of common contagion during 2010. This picture is nuanced when assuming two-factor model, where the two factors are identified as a safe and a troubled economy factor. The common contagion identified in the one-factor model corresponds to the impact of safe country shocks on the troubled economies. Hence, although government bonds of safe and troubled economies are very interlinked, one cannot conclude that the troubled economies have been contagious on the safe ones