Banking sector contingent liabilities and sovereign risk

Serkan Arslanalp and Yin Liao ()

Journal of Empirical Finance, 2014, vol. 29, issue C, 316-330

Abstract: The global financial crisis has underscored the need to pay attention to contingent government liabilities that could arise from bank failures for sovereign risk management. This paper proposes a simple method to construct a contingent liability index (CLI) for a banking sector that takes into account the size and concentration of the banking system, market expectations of bank defaults, and perceptions of government support to each bank. This method allows us to track potential government liabilities related to bank failures for 32 advanced and emerging economies on a monthly basis from 2006 to 2013. Furthermore, we find that the CLI is a significant determinant of sovereign CDS spreads. Our results suggest that a 1 percentage point increase in the CLI is associated with an increase in sovereign CDS spreads by 24 basis points for advanced economies and 75 basis points for emerging markets on average.

Keywords: Contingent liabilities; Sovereign risk; Banking sector (search for similar items in EconPapers)
JEL-codes: G13 G21 G38 (search for similar items in EconPapers)
Date: 2014
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Citations: View citations in EconPapers (13)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:empfin:v:29:y:2014:i:c:p:316-330

DOI: 10.1016/j.jempfin.2014.08.007

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