Sovereign Spread Volatility and Banking Sector

44 Pages Posted: 8 Mar 2019

See all articles by Vivek Sharma

Vivek Sharma

Università LUISS Guido Carli

Edgar Silgado-Gómez

University of Rome Tor Vergata

Date Written: December 2018

Abstract

Using structural vector autoregression augmented with stochastic volatility (SVAR-SV), we document that in late 2000s there were large spikes in volatility of spreads on peripheral eurozone government bonds. This increased volatility entailed a significant decline in bank credit to nonfinancial sector and real economic activity. We rationalize these results in a New Keynesian dynamic stochastic general equilibrium (DSGE) model with financial intermediation. In our framework, a rise in spread volatility erodes banks’ net worth and constrains their balance sheets. The banks respond by slashing their lending to real sector, dampening the economy as a whole. Results from the model match our empirical findings.

Keywords: Sovereign Spread Volatility, Banks, SVAR-SV, NK-DSGE

JEL Classification: E32, E44, F30

Suggested Citation

Sharma, Vivek and Silgado-Gómez, Edgar, Sovereign Spread Volatility and Banking Sector (December 2018). CEIS Working Paper No. 454. Available at SSRN: https://ssrn.com/abstract=3349192 or http://dx.doi.org/10.2139/ssrn.3349192

Vivek Sharma

Università LUISS Guido Carli ( email )

Rome
Italy

Edgar Silgado-Gómez (Contact Author)

University of Rome Tor Vergata ( email )

Via Cracovia 1
Rome, 00133
Italy

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