The Time-Spatial Dimension of Eurozone Banking Systemic Risk

Abstract

In this paper, we measure the systemic risk with a novel methodology, based on a “spatial-temporal” approach. We propose a new bank systemic risk measure to consider the two components of systemic risk: cross-sectional and time dimension. The aim is to highlight the “time-space dynamics” of contagion, i.e., if the CDS spread of bank i depends on the CDS spread of other banks. To do this, we use an advanced spatial econometrics design with a time-varying spatial dependence that can be interpreted as an index of the degree of cross-sectional spillovers. The findings highlight that the Eurozone banks have strong spatial dependence in the evolution of CDS spread, namely the contagion effect is present and persistent. Moreover, we analyse the role of the European Central Bank in managing contagion risk. We find that monetary policy has been effective in reducing systemic risk. However, the results show that systemic risk does not imply a policy intervention, highlighting how financial stability policy is not yet an objective.

Bad or good neighbours: a spatial financial contagion study

“…Our work is close to the papers of Eder and Keiler (2015) and Foglia and Angelini (2019), that analyse the contagion risk applying a spatial autoregressive model (SAR). However, in contrast with them, we use a dySDM.…”

“…In the event of increased equity volatility, and therefore greater risk, capital tends to shift from risky assets to safe ones (flight-to-quality effect). This generates an increase in the credit risk spread of the former and a decrease in the yields of the latter (Jubinski and Lipton, 2012; Fuerst et al , 2015; Gubareva and Borges, 2016; Foglia and Angelini, 2019). However, it contradicts those obtained by Samaniego-Medina (2016), which showed that equity volatility has a positive sign.…”

“…Nevertheless, an important contagion effect is verified for banks that belong to the same state, the same Federal-Reserve district and the same size. Foglia and Angelini (2019) estimated the contagion spillover risk between Eurozone bank using the Blasques et al (2016) model. Their results suggest that the contagion depends on the bank’s “proximity”, highlighting how the systemic risk is persistent in the euro area banks.…”

“…Hellwig (2014) shows that there are different channels of propagation of shock, for example, via physical exposures (claim and liabilities), via Information-based (systemic run) and via market and price. Following Foglia and Angelini (2019), we consider these channels by using three different interaction matrices. The first one is based on the financial claim, provided by BIS, (as in Milcheva and Zhu, 2016; Calabrese et al , 2017; Tonzer, 2015) to incorporate the physical exposures.…”

“…Therefore, as point out by Eder and Keiler (2015), the matrix can be treated as exogenous. Moreover, several papers use this stock correlation matrix (Eder and Keiler, 2015; Blasque et al , 2016; Catania and Billè, 2017; Foglia and Angelini, 2019).…”