The Market Impact Of The Involvement Of The Troika In Crisis-Affected Countries During The European Sovereign Debt Crisis
Dimitrios V Kousenidis
Aristotle University of Thessaloniki
July 17, 2016
This paper examines whether the release of news about policy interventions by the troika (EU/ECB/IMF) in the crisis-affected EU countries (Cyprus, Greece, Ireland, Italy, Portugal, and Spain) and about the policy responses of these countries’ governments had impacts on the return and risk of stocks in the financial and real-economy sectors of these countries. The results indicate that the involvement of the troika managed to reverse some of the unfavourable market effects of the crisis. Moreover, the policy response of national governments was found to have stronger effects in the markets of the affected countries implying that investors likely waited for the response of the national governments before they reacted to the policy actions of the troika. The simultaneous release of news from the troika and from national governments had adverse effects on the returns and risk of the firms in the real economy sectors, suggesting that, cross-news announcements conveyed negative information in the markets. The implications of these results are discussed in the paper.
The Market Impact Of The Involvement Of The Troika In Crisis-Affected Countries During The European Sovereign Debt Crisis – Introduction
The recent European sovereign debt crisis (ESDC) originated in Greece and spread to other Eurozone countries in unsustainable fiscal positions (Ireland, Italy, Cyprus, Portugal, and Spain), jeopardising the stability of the monetary union. The response of the European Union (EU) was the establishment of the Financial Stabilization Mechanism, which used funds from other Eurozone countries, the European Central Bank (ECB) and the International Monetary Fund (IMF) to provide aid to Eurozone countries in difficulties. In addition, the EU, ECB and IMF (henceforth, the troika) imposed a number of reforms and austerity measures on crisis-affected Eurozone countries to prevent further deterioration of the macroeconomic and market conditions in these countries.
Since the outbreak of the ESDC, its origins, mechanics and implications have been discussed and analysed (Goddard et al., 2009; Arghyrou and Tsoukalas, 2010; De Grauwe, 2010; Kouretas and Vlamis, 2010; Ardagna and Caselli, 2012; Arghyrou and Kontonikas, 2012; Mink and de Haan, 2013). However, there is no comprehensive set of evidence of the impact of the troika’s funding programs and policy interventions on the stock markets of the affected countries. The relevant literature focuses mostly on the involvement of the IMF in affected countries during the Asian, Mexican and Russian crises. Even these research results, however, are mixed and conflicting and show that IMF involvement has not always brought about the desired results. Many empirical studies reviewed in the following section of the paper address the question as to whether the IMF’s intervention in a number of countries has restored or damaged confidence in domestic and international markets, reporting results that are mixed and sometimes conflicting. In some cases, the IMF has also been accused of inducing moral hazard in international financial markets because the prospect of its financial aid leads to excessive lending and borrowing (Brealey and Kaplanis, 2004; Döbeli and Vanini, 2004).
The involvement of troika authorities in crisis-affected Eurozone countries during the ESDC differed from the interventions of the IMF in three major aspects. First, Eurozone countries are part of a monetary union, and therefore, they cannot exercise monetary policy to counter the unfavourable effects of the crisis. Second, a likely default by one of these countries could jeopardise the credibility of the entire Eurozone. Therefore, the EU had strong motivations to assist these countries. Finally, unlike the IMF, which is an international support institution, the troika operates on a regional level and aims to support European countries in economic difficulties (Gogstad et al., 2014). It would therefore, be interesting to see whether such a regional institution is more or less effective than an international one in restoring confidence in the markets of member states during a crisis. However, the few recent studies in this area focus on the involvement of the troika in Greece and do not support generalisable conclusions (Gogstad et al., 2014; Kosmidou et al., 2015).
The present study examines the stock market effects of policy-related news announcements during the ESCD and extends the literature in three major ways. First, this study uses data from the six Eurozone countries most heavily affected by the ESDC from 2005 to 2014 (Cyprus, Greece, Ireland, Italy, Portugal and Spain) and measures the crisis’s effects on risk and wealth in various economic sectors of these countries. Second, this study analyses a broad set of news releases concerning the troika authorities’ policy changes and interventions and the policy responses, regulatory measures and stimulus packages of the affected Eurozone states’ governments. Two dummy variables stand for news announcements about the troika’s policy actions and interventions and about national governments’ policy responses and regulatory measures. These dummy variables enabled testing whether news announcements concerning policy interventions and regulatory actions restored or damaged confidence in EU capital markets and whether troika authorities or national governments were more effective at reversing the negative stock market effects of the crisis. Finally, by distinguishing between effects on the financial sectors and effects on other sectors of the real economy, the present study provides insight into whether some sectors benefited or suffered more than others from the policy interventions of the troika.
The key empirical results of the present study are as follows. The troika’s interventions in the six crisis-affected Eurozone countries caused significant shifts in the returns of stocks in four of the six sectors (industrial, banking, other financials and services and utilities sectors) and bore significant risk effects in two of these sectors (banking and services and utilities sectors). On the other hand, the policy response of the national governments caused significant shifts in the returns of stocks of the same four sectors and had significant impact in the systematic risk of the stocks in all six sectors. The observable implication is that investors considered the policy actions of the troika to have a positive impact on the markets; however, they likely waited for the policy response of the national governments before they reacted to the intended actions of the troika. The results also revealed that real economy firms exhibited a positive shift in risk and a negative shift in returns upon cross-news announcements. A likely explanation is that investors in these sectors viewed the simultaneous release of news from the troika and the national governments to associate with costly measures (i.e., austerity, costly reforms, tight fiscal policies, increased taxation) and disregarded the benefits that these measures likely had (i.e., liquidity support or other government guarantees).
These results are robust to a number of alternative specifications and have important implications. For example, the troika’s policy interventions appear to have been beneficial for investors as they likely created positive effects, reducing risk in financial markets during periods of market turmoil. Another important implication concerns the degree to which the reaction of national governments influenced the effectiveness of the troika’s supporting actions, which could help regulators, policy makers and investors