Policy uncertainty, interest rate environment and the dynamic correlation between sovereign and bank default risk
18 Pages Posted: 30 Sep 2020 Last revised: 26 Jul 2021
Date Written: June 11, 2021
This study assesses the impact of policy uncertainty and the interest rate environment on the sovereign-bank nexus considering 48 banks in 14 countries. By applying principal component analysis to bank CDS premia in a country, the dynamic conditional correlation between sovereign CDS premia and the common variation underlying bank CDS is specified. Fixed effects panel regression analysis shows that the sovereign-bank correlation significantly increases in times of great policy uncertainty, low bank interest margins, high interbank market rates, and a low ratio of bank Tier 1 capital.
Keywords: Sovereign-Bank Nexus, Economic Policy Uncertainty, Interest Rates, Dynamic Conditional Correlation.
JEL Classification: E40, E44, E58, G21, G28
Suggested Citation: Suggested Citation