Assessing the sovereign-bank interdependence in Eurozone core countries

Salvatore Capasso, Marcella D’Uva, Cristiana Fiorelli and Oreste Napolitano

Journal of Economic Studies, 2024, vol. 52, issue 5, 968-982

Abstract: PurposeThe aim of this study is to determine whether financial contagion is transmitted through macroeconomic fundamentals, not only in weaker countries but also in strong European Monetary Union (EMU) economies.Design/methodology/approachThis study conducts, for the first time, an analysis of the spillover effects resulting from a shock to Italian sovereign risk on the banking systems and credit default swaps (CDS) of five EMU core countries during the period 2012–2018, employing a global vector autoregressive (GVAR) approach. Spatial interdependence is quantified through the cross-country distance in the deficit-to-gross domestic product (GDP) ratio.FindingsThe findings reveal the existence of both a “doom-loop” between banks and sovereign bonds and a “bad neighbours” effect. The susceptibility to spillovers is notably higher in economies displaying a larger deficit-to-GDP ratio. These results suggest that differences in fiscal fundamentals could drive financial contagion even within core countries, indicating a need for evaluating the stability of the entire EMU system.Originality/valueUnlike previous studies, we utilize the cross-country distance in the deficit-to-GDP ratio as a measure of fiscal fundamentals distance for the countries under investigation. To the best of our knowledge, our study is the first to analyse this matter in EMU core countries using a GVAR methodology.

Keywords: Sovereign risk; Spillovers; GVAR (search for similar items in EconPapers)
Date: 2024
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Persistent link: https://EconPapers.repec.org/RePEc:eme:jespps:jes-01-2024-0050

DOI: 10.1108/JES-01-2024-0050

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