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The robustness of the sovereign-bank interconnection: Evidence from contingent claims analysis

Marta Gómez-Puig (), Simon Sosvilla-Rivero () and Manish Singh ()
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Marta Gómez-Puig: Risckcenter Research group–IREA. Av. Diagonal 696; 08034 Barcelona ,Spain
Manish Singh: Risckcenter Research group–IREA. Av. Diagonal 696; 08034 Barcelona ,Spain

No 201804, IREA Working Papers from University of Barcelona, Research Institute of Applied Economics

Abstract: We analyze the interconnection between the sovereign and banking sector risk in the peripheral euro area countries over the 2004Q4-2013Q2 period. Applying the contingent claims methodology, we build indicators of sovereign and banking sector risk (incorporating both market and balance sheet based information) and assess their interconnection in comparison with existing market-based indicators of banking and sovereign distress. We use three different statistical measures of interconnection based on principal components analysis, Granger causality network and Diebold-Yilmaz's connectedness index, and apply them to quarterly credit risk data. The empirical results shows strong connectedness and comovement between country-level banking and sovereign risk indicators. We find evidence of bi-directional bank-sovereign linkage for Spain and Italy during the European sovereign debt crisis period. For the late crisis period, we find weak interconnection and more divergence across the various risk indicators. Our findings also suggest that secondary and derivatives market indices are more driven by common underlying factors than are contingent claim based risk measures.

Keywords: sovereign risk; bank risk; sovereign-bank nexus; contingent claims. JEL classification:G13; G21; G33; H63. (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-eec
Date: 2018-02, Revised 2018-02
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