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A Comprehensive Approach to Measuring the Relation Between Systemic Risk Exposure and Sovereign Debt

51 Pages Posted: 26 Jul 2013 Last revised: 25 Jun 2016

Michael S. Pagano

Villanova University - Villanova School of Business

John Sedunov III

Villanova University - Department of Finance

Date Written: February 4, 2016

Abstract

Using an integrated model to control for simultaneity, as well as new risk measurement techniques such as Adapted Exposure CoVaR and Marginal Expected Shortfall (MES), we show that the aggregate systemic risk exposure of financial institutions is positively related to sovereign debt yields in European countries in an episodic manner, varying positively with the intensity of the financial crisis facing a particular nation. We find evidence of a simultaneous relation between systemic risk exposure and sovereign debt yields. This suggests that models of sovereign debt yields should also include the systemic risk of a country’s financial system in order to avoid potentially important mis-specification errors. We find evidence that systemic risk of a country’s financial institutions and the risk of sovereign governments are inter-related and shocks to these domestic linkages are stronger and longer lasting than international risk spillovers. Thus, the channel in which domestic sovereign debt yields can be affected by another nation’s sovereign debt is mostly an indirect one in that shocks to a foreign country’s government finances are transmitted to that country’s financial system which, in turn, can spill over to the domestic financial system and, ultimately, have a destabilizing effect on the domestic sovereign debt market.

Keywords: Systemic Risk, Banking Crises, Sovereign Risk, Contagion, Financial Institutions

JEL Classification: G01, G21, G28, H63

Suggested Citation

Pagano, Michael S. and Sedunov, John, A Comprehensive Approach to Measuring the Relation Between Systemic Risk Exposure and Sovereign Debt (February 4, 2016). Journal of Financial Stability, Volume 23, April 2016, 62-78. Available at SSRN: https://ssrn.com/abstract=2298273 or http://dx.doi.org/10.2139/ssrn.2298273

Michael Pagano

Villanova University - Villanova School of Business ( email )

800 Lancaster Avenue
Villanova, PA 19085-1678
United States
(610) 519-4389 (Phone)

HOME PAGE: http://www90.homepage.villanova.edu/michael.pagano

John Sedunov (Contact Author)

Villanova University - Department of Finance ( email )

800 Lancaster Ave.
Villanova, PA 19085
United States
610-519-4374 (Phone)

HOME PAGE: http://homepage.villanova.edu/john.sedunov/

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