Correlation and coordination risk


We study the potential role of correlated refinancing abilities among different countries for the disruption of government bond markets in a currency union. Following Morris and Shin (Eur Econ Rev 48(1):133–153, 2004) we use a global games framework and model the simultaneous investment decision into two assets, which are subject to correlated fundamental states, as a coordination problem with correlated imperfect information. Based on this model we evaluate the role of information about one country for the coordination of creditors of another country. We find, however, that the contagious effects on the price of debt precipitated through correlation are modest. Hence, assuming that investors behave as modeled in the global game, we conclude that correlated fundamentals that precipitate informational spillovers appear to be unlikely to play a major role for e.g. the disruption of some Eurozone government bond markets in the aftermath of the recent financial and economic crisis.

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  1. 1.

    Country characteristics that potentially affect spreads are e.g. outstanding government debt and government deficits, inflation, the current account, the real effective exchange rate, economic growth (Aizenman et al. 2013; De Grauwe and Ji 2013).

  2. 2.

    It is quite common to use the VIX index that is representing the implied volatility of S&P 500 stock market index options, to proxy global risk aversion (De Santis 2012; Beetsma et al. 2013).

  3. 3.

    In the literature, news about other countries is e.g. proxied by changes in sovereign ratings (De Santis 2012) or events associated with high price fluctuations (Metiu 2012; Mink and de Haan 2013).

  4. 4.

    Examples are the Outright Monetary Transactions (OMT) Program and the establishment of the European Stability Mechanism (ESM).

  5. 5.

    Pagano and von Thadden (2004) as well as Manganelli and Wolswijk (2009) argue that as the Euro was introduced, the exchange rate risk more or less vanished and identify this as a the major driver of convergence of government bond yields. Sims (2012), on the other hand, argues, that the provisions (treating bonds of European countries similarly) for collateral that is accepted by the ECB are the major cause for the convergence of bond yields.

  6. 6.

    In addition, the institutional architecture of currency unions generates a number of contingent liabilities among the participating countries and business cycle correlation tends to increase once countries join a currency union (Frankel and Rose 1998; de Haan et al. 2008; Enders et al. 2013).

  7. 7.

    Global games were first studied by Carlsson and van Damme (1993) and further popularized by Morris and Shin (1998), who applied the global games refinement in a macroeconomic context. They can be applied to wide range of decision problems where coordination risk and incomplete information is involved. In such settings, the agents’ payoffs depend on the actions of others as well as on an economic fundamental which is not perfectly observable.

  8. 8.

    There is not one single unambiguous definition of contagion but rather disagreement on which interdependencies and spill-overs qualify as contagion and which do not. Most papers, however, agree that the transmission of a shock through non-traditional channels such as trade, banking relations, or investment flows constitutes contagion (see e.g. Forbes 2012 for a comprehensive discussion of the literature). In this broad sense, the informational interdependencies we investigate in this paper may be referred to contagion.

  9. 9.

    For an overview see e.g. Kaminsky et al. (2003).

  10. 10.

    This is equivalent to using Bayes rule. For a discussion of Bayes rule applied to bivariate normal distributions see Lehmann and Casella (1998) and DeGroot (2004).

  11. 11.

    Scripts to these simulation exercises are available upon request.


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Correspondence to Martin Geiger.

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Geiger, M., Hule, R. Correlation and coordination risk. Ann Finance 15, 155–177 (2019).

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  • Government bond refinancing
  • Global games
  • Creditor coordination
  • Currency union

JEL Classification

  • D82
  • G12