Financial Sector Linkages and the Dynamics of Bank and Sovereign Credit Spreads
64 Pages Posted: 17 Mar 2012 Last revised: 16 Apr 2013
Date Written: March 28, 2013
We show that cross-border financial linkages are priced in CDS markets. We construct a measure of the foreign exposure risk of a country's banking system based on the composition of its foreign exposures. Our measure helps explain CDS premia of banks. Implicit and explicit guarantees extended to a country's banking system in turn affect the CDS premia of the sovereign. As a consequence, foreign exposures of banks impact the dynamics of sovereign CDS spreads. Another measure including both foreign and domestic assets of the banks is highly signicant in explaining bank CDS spreads even before the onset of the crisis.
Keywords: Credit risk, banks, sovereign risk
JEL Classification: G01, G15, G21
Suggested Citation: Suggested Citation