An anatomy of credit risk transfer between sovereign and financials in the Eurozone crisis

Abstract

Use policyThe full-text may be used and/or reproduced, and given to third parties in any format or medium, without prior permission or charge, for personal research or study, educational, or not-for-prot purposes provided that:• a full bibliographic reference is made to the original source • a link is made to the metadata record in DRO • the full-text is not changed in any way The full-text must not be sold in any format or medium without the formal permission of the copyright holders.Please consult the full DRO policy for further details. AbstractIn this paper we assess the effectiveness of large scale bailouts aiming at preventing a financial crisis from further propagating into a systemic risk. We examine the structural changes in the relationship between the sovereign and financial institutions' credit default swap spreads during the European sovereign debt crisis. Before the first Greek bailout by the EFSF, the sovereign and financial sectors exhibit a two-way feedback effect for both the short and the long runs. Crucially, we find that after the first Greek bailout, shocks in the financial sector either exert significantly negative impacts or lose influences on the sovereign sector. In contrast, all the later bailouts by the EFSF (the second Greek bailout, Irish and Portugal bailouts) do not show this pattern change in the two-way risk transfer relationship.

The sovereign-bank nexus in peripheral euro area: Further evidence from contingent claims analysis

“…From an empirical perspective, a large literature has also focused its analysis on the sovereign-bank nexus [Acharya et al (2014), Kallestrup et al (2016), Beltratti and Stulz (2015), Yu (2017), Banerjee et al (2016), Fratzscher and Rieth (2018) and Klinger and Teplý (2016), among them]. In particular, using CDS spreads on European sovereigns and banks for the period 2007-11, Acharya et al (2014) find empirical evidence to support the bi-directional negative feedback loop between banking and sovereign risk during the recent crisis.…”

“…In a related empirical work, Yu (2017) analysing the dynamic linkage between European sovereign and bank CDS spreads from 2006 to 2012, shows that risk initially transferred from banks to sovereigns soon led to a reverse spillover due to deteriorating fiscal conditions. Moreover, Banerjee et al (2016) assess the effectiveness of large scale bailouts during the European sovereign debt crisis and show that before the first Greek bailout, the sovereign and financial sectors exhibit a two-way feedback effect, but the pattern disappears during all later bailouts. Finally, Klinger and Teplý (2016) examine the link between financial system and sovereign debt crises by examining sovereign support to banks and banks' resulting exposure to the bonds issued by weak sovereigns that is reflected in the higher CDS spreads of these sovereigns.…”

“…While acknowledging the achievements of various studies that analyse systemic risk in the sovereign and banking sector [Acharya et al (2014), Kallestrup et al (2016), Beltratti and Stulz (2015), Yu (2017), Banerjee et al (2016) and Klinger and Teplý (2016), just to name a few], 1 to our knowledge, this is the first paper that examines the sovereign-bank risk interconnection using in both cases an indicator based on the contingent claims analysis (CCA) methodology -which includes both accounting metrics and market-based measures. Then, our results will be compared with those obtained using the existing market-based indicators of bank and sovereign distress.…”

Extreme Returns in the European financial crisis

“…What is this paper's incremental contribution to the literature? First, we study for effects that existed in the equity markets during the European financial crisis, which were (quite surprisingly) not sufficiently examined in the previous literature, which typically studies for ‘contagion’ effects on sovereign bonds and CDS markets (Missio and Watzka, ; Missio and Watzka, ; Metiu, ; Abad et al ., ; Gündüz and Kaya, ; Fabozzi et al ., ; Banerjee et al ., ). The study of equity markets is significant, since they are the most liquid markets and have the highest trading volume.…”

Time-Variation in the Pricing of Country Fundamentals in Sovereign Credit Spreads

“…On the other hand, for instance Buschmann and Schmaltz (2016) and Bocola (2016) brought evidence of bank credit risk being affected by sovereign credit risk. The two-way interdependence between bank and sovereign credit risk was empirically supported by many authors (De Bruyckere et al, 2013;Banerjee, Hung and Lo, 2016;Betz et al, 2016;Pagano and Sedunov, 2016;Gibson, Hall and Tavlas, 2017).…”