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Sovereigns and banks in the euro area: A tale of two crises

Marta Gómez-Puig (), Simon Sosvilla-Rivero () and Manish K. Singh ()
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Manish K. Singh: Department of Economic Theory, Universitat de Barcelona

No 15-01, Working Papers from Asociación Española de Economía y Finanzas Internacionales

Abstract: This study attempts to identify and trace inter-linkages between sovereign and banking risk in the euro area. To this end, we use an indicator of banking risk in each country based on the Contingent Claim Analysis literature, and 10-year government yield spreads over Germany as a measure of sovereign risk. We apply a dynamic approach to testing for Granger causality between the two measures of risk in 10 euro area countries, allowing us to check for contagion in the form of a significant and abrupt increase in short-run causal linkages. The empirical results indicate that episodes of contagion vary considerably in both directions over time and within the different EMU countries. Significantly, we find that causal linkages tend to strengthen particularly at the time of major financial crises. The empirical evidence suggests the presence of contagion, mainly from banks to sovereigns.

Keywords: sovereign debt crisis; banking crisis; Granger-causality; time-varying approach; “distance-to-default”; euro area. (search for similar items in EconPapers)
JEL-codes: C22 E44 G01 G13 G21 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ban, nep-cfn, nep-eec and nep-mac
Date: 2015-01
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