Transmission of government default risk in the eurozone

• Non-linear SVAR model to study drivers of government bond spreads presented.
• Drivers are idiosyncratic risk factors, spillovers or immediate shock transmission.
• Novel way to test for stability of immediate shock transmission linkages presented.
• Paper considers Eurozone's government bond spreads during the euro crisis.
• Crisis countries' rising spreads due to heterogeneous reasons.

This paper analyzes the reasons behind the rising ten year government bond spreads in the eurozone during the recent euro debt crisis. We develop a structural vector autoregressive model that allows us to test whether the upsurges in the spreads reflect breaks in the instantaneous shock propagation mechanisms between the spreads (contagion), changing dynamical effects, or changing country specific risk factors. Especially, a new approach to test the stability of the instantaneous shock propagation mechanisms is introduced. Our results show that although contagion appears as the single most important reason for the increasing spreads, there are notable differences between the countries, for example and Ireland, Spain and Italy see statistically significant increases in their country specific risk factors.