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Government guarantees and the two-way feedback between banking and sovereign debt crises

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  • Leonello, Agnese

Abstract

This paper studies the effects of government guarantees on the interconnection between banking and sovereign debt crises in a framework where both the banks and the government are fragile and the credibility and feasibility of the guarantees are determined endogenously. The analysis delivers some new results on the role of guarantees in the bank-sovereign nexus. First, guarantees emerge as a key channel linking banks’ and sovereign stability, even in the absence of banks’ holdings of sovereign bonds. Second, depending on the specific characteristics of the economy and the nature of banking crises, an increase in the size of guarantees can be beneficial for the bank-sovereign nexus in that it enhances financial stability without undermining sovereign solvency.

Suggested Citation

  • Leonello, Agnese, 2018. "Government guarantees and the two-way feedback between banking and sovereign debt crises," Journal of Financial Economics, Elsevier, vol. 130(3), pages 592-619.
  • Handle: RePEc:eee:jfinec:v:130:y:2018:i:3:p:592-619
    DOI: 10.1016/j.jfineco.2018.04.003
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    More about this item

    Keywords

    Bank runs; Sovereign default; Strategic complementarity; Government bond yield;
    All these keywords.

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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