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

See all articles by Stephan Bales

Stephan Bales

University of Hohenheim

Hans-Peter Burghof

University of Hohenheim

Date Written: June 11, 2021

Abstract

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

Bales, Stephan and Burghof, Hans-Peter, Policy uncertainty, interest rate environment and the dynamic correlation between sovereign and bank default risk (June 11, 2021). Economics Letters, Vol. 206, September, 2021, Available at SSRN: https://ssrn.com/abstract=3674420 or http://dx.doi.org/10.2139/ssrn.3674420

Stephan Bales (Contact Author)

University of Hohenheim ( email )

Fruwirthstr. 48
Stuttgart, 70599
Germany

Hans-Peter Burghof

University of Hohenheim ( email )

Schloss Hohenheim
510F
Stuttgart, 70599
Germany
+49 711 459 22900 (Phone)
+49 711 459 23448 (Fax)

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