Credit Spread Interdependencies of European States and Banks During the Financial Crisis
38 Pages Posted: 17 May 2011 Last revised: 16 Jan 2012
Date Written: December 10, 2011
We investigate the interdependence of the default risk of several Eurozone countries (France, Germany, Italy, Ireland, Netherlands, Portugal, and Spain) and their domestic banks during the period June 2007 - May 2010, using daily credit default swaps (CDS). Bank bailout programs changed the composition of both banks’ and sovereign balance sheets and, moreover, affected the linkage between the default risk of governments and their local banks. Our main findings suggest that in the period before bank bailouts the contagion disperses from bank credit spreads into the sovereign CDS market. After bailouts, a financial sector shock affects more strongly sovereign CDS spreads in the short-run, however, the impact becomes insignificant at a long horizon. Furthermore, government CDS spreads become an important determinant of banks’ CDS series. The interdependence of government and bank credit risk is heterogeneous across countries, but homogeneous within the same country.
Keywords: credit default swaps, financial crisis, private-to-public risk transfer, bailout programs, government interventions, cointegration, generalized impulse responses
JEL Classification: C58, G01, G18, G21
Suggested Citation: Suggested Citation