Impact of the coronavirus pandemic crisis on the financial system in the eurozone

• Published date: 01 October 2020
• DOI: http://doi.org/10.1002/jcaf.22466
• Date: 01 October 2020
• Author: Takayasu Ito

BLIND PEER REVIEW

Impact of the coronavirus pandemic crisis on the financial

system in the eurozone

Takayasu Ito

School of Commerce, Meiji University,

Chiyoda City, Tokyo, Japan

Correspondence

Takayasu Ito, School of Commerce, Meiji

University, Chiyoda City, Tokyo, Japan.

Email: tito747@meiji.ac.jp

Abstract

The stress in the financial system in five eurozone countries (Germany,

France, Italy, Portugal, and Spain) was not connected before the COVID-19

pandemic crisis. Credit default swap premiums were priced independently, not

incorporating the sovereign risk of the eurozone as a whole. However, during

the period of pandemic crisis, the stress was connected in five countries. The

financial market was cautious about the increased fiscal deficit caused by mas-

sive spending in the pandemic crisis, fearing that the deficit might cause

increased risk in the financial system of the eurozone as a whole. The symp-

toms of financial crisis sprouted after the pandemic crisis started. We need to

monitor whether countermeasures taken by European Central Bank (ECB)

and European Union (EU) contribute to the stability of financial system in the

eurozone.

KEYWORDS

COVID-19 pandemic crisis, credit default swap, eurozone, financial system

1|INTRODUCTION

As the Council of the European Union states, the corona-

virus (COVID-19) pandemic crisis (hereafter pandemic

crisis) constitutes an unprecedented challenge with very

severe socioeconomic consequences. The outbreak of the

pandemic in the eurozone was discovered in northern

Italy around the end of February 2020, from where it

quickly spread to other EU countries. This paper focuses

on the stress in the financial system caused by the

increased premium in sovereign credit default swaps

(CDSs) of five eurozone nations (Germany, France, Italy,

Portugal, and Spain) during the early stage of the pan-

demic crisis.

Originally, CDS was introduced to serve as an insur-

ance. It is a financial swap agreement whereby the seller

will compensate the buyer if there is a credit event. As

mentioned in Ito (2015), “the buyer of the CDS makes a

series of payments to the seller and, in exchange, receives

a compensation payoff if there is a default, whereupon

the seller retakes possession of the defaulting bond or

loan.”When the credit risk increases in a country, the

CDS premium increases. We can see CDS premiums

because they are traded every day on the financial mar-

ket, and it is therefore appropriate to use the CDS pre-

mium to measure stress in the financial system.

As the pandemic crisis deepened in northern Italy

around the end of February 2020, the CDS premium rose

dramatically in countries such as Italy, Spain, and Portu-

gal. The financial market was cautious about the

increased fiscal deficit caused by the massive spending in

the pandemic crisis. This paper analyzes the comovement

of sovereign CDSs in five eurozone countries during the

outbreak of the pandemic crisis. The research question is

whether the stress in the countries' financial systems is

connected. If so, the concern in the financial market

would be that the fiscal deficit might impair financial sta-

bility in the rest of the eurozone. This paper is the first

one to analyze the stress in the eurozone financial system

during the pandemic crisis by using the data of CDS

Received: 23 June 2020 Revised: 22 July 2020 Accepted: 24 July 2020

DOI: 10.1002/jcaf.22466

J Corp Acct Fin. 2020;31:15–20. wileyonlinelibrary.com/journal/jcaf © 2020 Wiley Periodicals LLC 15