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Avoiding the fall into the loop: Isolating the transmission of bank-to-sovereign distress in the euro area and its drivers

Hannes Böhm and Stefan Eichler

No 19/2018, IWH Discussion Papers from Halle Institute for Economic Research (IWH)

Abstract: We isolate the direct bank-to-sovereign distress channel within the eurozone's sovereign-bank-loop by exploiting the global, non-eurozone related variation in stock prices. We instrument banking sector stock returns in the eurozone with exposure-weighted stock market returns from non-eurozone countries and take further precautions to remove any eurozone crisis-related variation. We find that the transmission of instrumented bank distress, while economically relevant, is significantly smaller than the corresponding coefficient in the unadjusted OLS framework, confirming concerns on reverse causality and omitted variables in previous studies. Furthermore, we show that the spillover of bank distress is significantly stronger for countries with poorer macroeconomic performances, weaker financial sectors and financial regulation and during times of elevated political uncertainty.

Keywords: sovereign-bank-loop; bank distress; instrumental variable estimation; bank exposures; macroeconomic performance (search for similar items in EconPapers)
JEL-codes: E44 F3 G15 G21 G28 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ban, nep-eec and nep-mac
Date: 2018
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:iwhdps:192018

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