Structural breaks in the interaction between bank and sovereign default risk

Lidija Lovreta () and Joaquín López Pascual ()
Additional contact information
Lidija Lovreta: EADA Business School
Joaquín López Pascual: University Rey Juan Carlos

SERIEs: Journal of the Spanish Economic Association, 2020, vol. 11, issue 4, No 5, 559 pages

Abstract: Abstract The recent financial and sovereign debt crises emphasized the interdependence between bank and sovereign default risk and showed that major shocks may lead to a self-reinforcing negative spiral. In this paper, we analyse the pattern of interaction between bank and sovereign default risk by endogenously estimating the timing of structural breaks. The endogenous approach avoids the problem of choosing the number and the location of important turning points associated with the exogenous selection of break dates, commonly applied in the literature. In addition, it provides additional insight to which (if any) of the many exogenously proposed breaks are of particular importance to one specific economy, which can help policy makers to structure their actions accordingly. Using Spain during the 2008–2012 period as an illustrative example, we find supporting evidence for the three distinctive phases, marked by the breaks in the early-January and mid-May 2010. The three phases are characterized with an evident change in the bank–sovereign interaction, and we detect a bi-directional relationship only during the interim phase, i.e. at the very peak of the European sovereign debt crisis. We show that endogenously identified turning points coincide with important public events that affect investors’ perception about the government’s capacity and willingness to repay debt and support distressed banks. Finally, we provide evidence that structural dependence in the system extends to the interaction between bank and sovereign default risk volatility.

Keywords: Credit default swaps; Structural breaks; Bank-sovereign nexus; Sovereign debt crisis (search for similar items in EconPapers)
JEL-codes: C58 G01 G28 (search for similar items in EconPapers)
Date: 2020
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (7)

Downloads: (external link)
http://link.springer.com/10.1007/s13209-020-00219-z Abstract (text/html)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:spr:series:v:11:y:2020:i:4:d:10.1007_s13209-020-00219-z

Ordering information: This journal article can be ordered from
http://www.springer.com/economics/journal/13209

DOI: 10.1007/s13209-020-00219-z

Access Statistics for this article

SERIEs: Journal of the Spanish Economic Association is currently edited by Nezih Guner

More articles in SERIEs: Journal of the Spanish Economic Association from Springer, Spanish Economic Association Contact information at EDIRC.
Bibliographic data for series maintained by Sonal Shukla () and Springer Nature Abstracting and Indexing ().