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A Pyrrhic Victory? Bank Bailouts and Sovereign Credit Risk

Viral Acharya, Itamar Drechsler and Philipp Schnabl

Journal of Finance, 2014, vol. 69, issue 6, 2689-2739

Abstract: type="main">

We model a loop between sovereign and bank credit risk. A distressed financial sector induces government bailouts, whose cost increases sovereign credit risk. Increased sovereign credit risk in turn weakens the financial sector by eroding the value of its government guarantees and bond holdings. Using credit default swap (CDS) rates on European sovereigns and banks, we show that bailouts triggered the rise of sovereign credit risk in 2008. We document that post-bailout changes in sovereign CDS explain changes in bank CDS even after controlling for aggregate and bank-level determinants of credit spreads, confirming the sovereign-bank loop.

Date: 2014
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Citations: View citations in EconPapers (652)

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Working Paper: A Pyrrhic Victory? Bank Bailouts and Sovereign Credit Risk (2011) Downloads
Working Paper: A Pyrrhic Victory? - Bank Bailouts and Sovereign Credit Risk (2011) Downloads
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