Connectedness of Stress in EMU Bank and Sovereign CDS: The Role Policy Measures 2008-2014

Abstract

This paper measures the connectedness in European Economic and Monetary Union (EMU) sovereign and bank CDS between April 2008 and December 2014, in order to understand the transmission of stress during the euro crisis. To this end, we perform a connectedness analysis using the framework proposed by Diebold and Yılmaz (2014). Second, we make use of a dynamic analysis to evaluate the net directional connectedness for each country and bank. Finally, we interpret the policy conclusions that stem from the results. We find that core countries' contribution to stability was particularly significant since Draghi's 'whatever it takes' speech. Bank risk played a role in enhancing sovereign risk. However, the systemic impact of banks changes rapidly once a crisis strikes, rendering the ex-ante determination of which banks are systemic and which banks will have a higher impact on the sovereign difficult.

Keywords: Connectedness, Bank risk, Sovereign risk, EMU

JEL Classification: C22, E44, G01, G13, G21