The state dependent impact of bank exposure on sovereign risk

Maximilian Podstawski and Anton Velinov

Journal of Banking & Finance, 2018, vol. 88, issue C, 63-75

Abstract: The theoretical literature remains inconclusive on whether changes in bank exposure to the domestic sovereign have an adverse effect on the sovereign risk position through a diabolic loop in the sovereign-bank nexus, or reduce perceived default risk by acting as a disciplinary device for the sovereign. In this paper we empirically analyze the impact of exogenous changes in bank exposure on the risk position of the sovereign within a Markov switching structural vector autoregressive in heteroscedasticity (MSH-SVAR) framework for a set of EMU countries. We add to the methodological literature by allowing for regime dependent shock transmissions according to the volatility state of the financial system. Finding support for both, a stabilizing and a destabilizing effect, we document a clear clustering among the country sample: rising bank exposure increased default risk for the EMU periphery, but decreased credit risk for the core EMU countries during times of financial stress.

Keywords: Markov-switching; Heteroscedasticity; Identification; Sovereign-bank interlinkages; Sovereign risk; Credit default swap; Contagion (search for similar items in EconPapers)
JEL-codes: C32 E44 G10 (search for similar items in EconPapers)
Date: 2018
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (11)

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Related works:
Working Paper: The State Dependent Impact of Bank Exposure on Sovereign Risk (2016)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:88:y:2018:i:c:p:63-75

DOI: 10.1016/j.jbankfin.2017.11.002

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