Bank-sovereign risk spillovers in the Euro Area

ABSTRACT

We investigate cross-sectional connectedness between Euro Area banking and sovereign risk. Average ‘distance-to- default’ based on all publicly listed banks headquartered in a particular country is used as an indicator of banking risk, while 10-year sovereign yield as the measure of sovereign risk. We find evidence of clustering among banks and sovereigns in peripheral and central countries. Except for peripheral countries banks, rest of the clusters are well isolated from each other.

KEYWORDS:

• Yield spreads
• bank risk
• spillover
• vector autoregression

JEL CLASSIFICATIONS:

• G13
• G21
• C58

Acknowledgments

We are very grateful to Fernando Fernandez-Rodriguez for his assistance with the research.

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

¹ Since VAR methodologies are sensitive to ordering in case of non-orthogonal shocks, we use a generalized VAR decomposition, invariant to ordering.

Additional information

Funding

This work was supported by the Instituto de Estudios Fiscales [grant IEF 151/2017] and the Spanish Ministry of Economy and Competitiveness [grant ECO2016-76203-C2-2-P].