Incorporating Creditors' Seniority into Contingent Claim Models: Applicarion to Peripheral Euro Area Countries

Research Institute of Applied Economics, Working Paper 2018/03, 1/54 pág

54 Pages Posted: 29 Jan 2019

See all articles by Marta Gómez-Puig

Marta Gómez-Puig

Economic Theory Department. University of Barcelona

Manish Singh

University of Barcelona; Indira Gandhi Institute of Development Research (IGIDR)

Simon Sosvilla-Rivero

UCM Institute for Economic Analysis

Date Written: February 7, 2018

Abstract

We analyze the interconnection between the sovereign and banking sector risk in the peripheral euro area countries over the 2004Q4-2013Q2 period. Applying the contingent claims methodology, we build indicators of sovereign and banking sector risk (incorporating both market and balance sheet based information) and assess their interconnection in comparison with existing market-based indicators of banking and sovereign distress. We use three different statistical measures of interconnection based on principal components analysis, Granger causality network and Diebold-Yilmaz's connectedness index, and apply them to quarterly credit risk data. The empirical results shows strong connectedness and comovement between country-level banking and sovereign risk indicators. We find evidence of bi-directional bank-sovereign linkage for Spain and Italy during the European sovereign debt crisis period. For the late crisis period, we find weak interconnection and more divergence across the various risk indicators. Our findings also suggest that secondary and derivatives market indices are more driven by common underlying factors than are contingent claim based risk measures.

Keywords: sovereign risk, bank risk, sovereign-bank nexus, contingent claims

JEL Classification: G13, G21, G33, H63

Suggested Citation

Gómez-Puig, Marta and Singh, Manish and Sosvilla-Rivero, Simon, Incorporating Creditors' Seniority into Contingent Claim Models: Applicarion to Peripheral Euro Area Countries (February 7, 2018). Research Institute of Applied Economics, Working Paper 2018/03, 1/54 pág. Available at SSRN: https://ssrn.com/abstract=3311524 or http://dx.doi.org/10.2139/ssrn.3311524

Marta Gómez-Puig

Economic Theory Department. University of Barcelona ( email )

Diagonal 690
Barcelona, 08034
Spain
34-93-4020113 (Phone)
34-93-4039082 (Fax)

Manish Singh

University of Barcelona ( email )

Gran Via de les Corts Catalanes, 585
Barcelona, 08007
Spain

Indira Gandhi Institute of Development Research (IGIDR) ( email )

Gen A.K. Vaidya Marg Santoshnagar
Goregaon (East)
Mumbai, Maharashtra 400065
India

Simon Sosvilla-Rivero (Contact Author)

UCM Institute for Economic Analysis ( email )

Carretera de Humera s/n
Madrid, Madrid 28223
Spain
+34913932626 (Phone)

HOME PAGE: http://www.ucm.es/info/ecocuan/ssr/

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