Sovereign and Financial-Sector Risk: Measurement and Interactions

Dale F. Gray () and Samuel Malone
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Dale F. Gray: Monetary and Capital Markets Department, International Monetary Fund, Washington, DC 20431

Annual Review of Financial Economics, 2012, vol. 4, issue 1, 297-312

Abstract: The complex spillover effects between sectors observed during the global financial crisis and recent European crisis make clear the importance of improving our understanding of the interactions and feedback mechanisms between sovereign and banking-sector risks. To that end, this paper presents a conceptual framework for analyzing the sovereign, banks, and their interlinkages based on contingent claims analysis (CCA). Our bank-by-bank framework uses balance-sheet data plus high-frequency market data in a way that measures risk exposures and can capture key risk transmission and feedbacks with the sovereign in real time. Risk transmission between banks and sovereigns can arise in the framework from several important sources: (a) bank holdings of risky sovereign debt, (b) explicit and implicit guarantees from sovereigns to banks, and (c) spillovers from sovereign spreads into bank borrowing costs. We illustrate the framework with several examples and ways forward to analyze multicountry sovereign and banking interactions.

Keywords: systemic risk; contingent claims analysis (search for similar items in EconPapers)
JEL-codes: E60 G21 (search for similar items in EconPapers)
Date: 2012
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Citations: View citations in EconPapers (8)

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