This article presents an intensity-based model of euro-area sovereign spreads. To identify liquidity-pricing effects, we exploit the information contained in the spreads between bonds issued by a German agency (KfW) and their sovereign counterparts. KfW’s liabilities being guaranteed by the German government, these spreads are essentially liquidity-driven. Liquidity effects are found to account for a sizeable share of spreads’ fluctuations. After having filtered risk premiums out of the spreads, we estimate the physical default probabilities of eleven countries. Physical probabilities of default are lower than risk-neutral ones, consistently with the existence of a nondiversifiable euro-area sovereign credit risk.

We define a disastrous default as the default of a systemic entity. Such an event is expected to have a negative effect on the economy and to be contagious. Bringing macroeconomic structure to a no-arbitrage asset-pricing framework, we exploit prices of disaster-exposed assets (credit and equity derivatives) to extract information on (i) the expected influence of a disastrous default on consumption and (ii) the probability of a financial meltdown. Using European data, we find that the returns of disaster-exposed assets are consistent with a systemic default being followed by a 2% decrease in consumption. The recessionary influence of disastrous defaults implies that financial instruments whose payoffs are exposed to such credit events carry substantial risk premiums. We also produce systemic risk indicators based on the probability of observing a certain number of systemic defaults or a sharp drop of consumption.