A Zero-Risk Weight Channel of Sovereign Risk Spillovers

49 Pages Posted: 13 Feb 2014 Last revised: 13 Jun 2018

Karolin Kirschenmann

Centre for European Economic Research (ZEW)

Josef Korte

Goethe University Frankfurt - Faculty of Economics and Business Administration

Sascha Steffen

Frankfurt School of Finance & Management

Date Written: June 4, 2018

Abstract

European banks are exposed to a substantial amount of risky sovereign debt. “Missing capital” in the banking system resulting from the zero-risk weight exemption for European sovereign debt amplifies the co-movement between sovereign CDS spreads and facilitates cross-border crisis spillovers. Risks spill over from risky peripheral sovereigns to safer core countries, but not in the opposite direction nor for exposures to countries not exempted from risk-weighting. Unfunded non-domestic sovereign bond exposures primarily affect CDS spreads of non-GIIPS banks, while domestic sovereign-to-bank linkages are particularly important for GIIPS banks. Spillovers are attenuated when banks fund their sovereign bond exposures with capital.

Keywords: sovereign debt, sovereign risk, spillovers, bank risk, CDS, zero risk weight exemption

JEL Classification: G01, G21, G28

Suggested Citation

Kirschenmann, Karolin and Korte, Josef and Steffen, Sascha, A Zero-Risk Weight Channel of Sovereign Risk Spillovers (June 4, 2018). Available at SSRN: https://ssrn.com/abstract=2395097 or http://dx.doi.org/10.2139/ssrn.2395097

Karolin Kirschenmann

Centre for European Economic Research (ZEW) ( email )

Germany
+496211235351 (Phone)

Josef Korte

Goethe University Frankfurt - Faculty of Economics and Business Administration ( email )

Mertonstrasse 17-25
Frankfurt am Main, D-60325
Germany

Sascha Steffen (Contact Author)

Frankfurt School of Finance & Management ( email )

Sonnemannstr. 9 -11
Frankfurt, 60314
Germany

HOME PAGE: http://www.sascha-steffen.de

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