European Central Bank research links euro disaster risk shocks to redemption-driven fund sales and larger spillovers in Asian sovereign bonds

The European Central Bank published a Working Paper examining whether investment funds transmit financial spillovers from local shocks across borders, using shocks to market beliefs about a rare euro area disaster as a test case for spillovers into Asian sovereign debt markets. Using security-level holdings data from 2014 to 2023, the paper finds that funds cut Asian sovereign bond holdings when euro disaster risk rises and that markets with greater investment-fund presence experience larger price spillovers, with sales largely explained by liquidity needs to meet investor redemptions rather than portfolio rebalancing. The analysis focuses on nine East and Southeast Asian sovereign bond markets (China, Hong Kong, Indonesia, Malaysia, the Philippines, Singapore, South Korea, Thailand and Vietnam) and identifies euro disaster risk shocks using changes in the spread between periphery and core euro area sovereign credit default swap premia. Across roughly 2,000 funds and a dataset covering about half of global investment-fund holdings of Asian sovereign debt, estimated sell-offs persist for several months and are similar in size to funds’ responses in euro area sovereign debt. Bonds in larger and more liquid markets are shed first, longer maturities are more sensitive, and US dollar-denominated Asian sovereign debt is comparatively resilient even after controlling for characteristics. At the security level, a higher fund share of outstanding amounts is associated with larger price declines following euro disaster risk shocks, which the paper interprets as evidence that funds amplify cross-border spillovers.