IDEAS home Printed from https://ideas.repec.org/p/bdi/wptemi/td_990_14.html
   My bibliography  Save this paper

How much of bank credit risk is sovereign risk? Evidence from the eurozone

Author

Listed:
  • Junye Li

    (ESSEC Business School)

  • Gabriele Zinna

    (Bank of Italy)

Abstract

We develop a multivariate credit risk model for the term structures of sovereign and bank credit default swaps. First, we separate the probability of joint defaults of large Eurozone sovereigns (systemic risk) from that of sovereign-specific defaults (country risk). Then, we quantify individual banks' exposures to each type of sovereign risk, as well as bank-specific credit risk. Banks� sovereign risk exposures vary with banks� size, their holdings of sovereign debt, and expected government support. On average, 45% of French and Spanish banks' credit risk consists in sovereign risk, compared with only 30% for Italian and 23% for German banks. Furthermore, short- to medium-term contracts are particularly informative on sovereign systemic risk.

Suggested Citation

  • Junye Li & Gabriele Zinna, 2014. "How much of bank credit risk is sovereign risk? Evidence from the eurozone," Temi di discussione (Economic working papers) 990, Bank of Italy, Economic Research and International Relations Area.
  • Handle: RePEc:bdi:wptemi:td_990_14
    as

    Download full text from publisher

    File URL: http://www.bancaditalia.it/pubblicazioni/temi-discussione/2014/2014-0990/en_tema_990.pdf
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Patrick Bolton & Olivier Jeanne, 2011. "Sovereign Default Risk and Bank Fragility in Financially Integrated Economies," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 59(2), pages 162-194, June.
    2. Durbin, Erik & Ng, David, 2005. "The sovereign ceiling and emerging market corporate bond spreads," Journal of International Money and Finance, Elsevier, vol. 24(4), pages 631-649, June.
    3. Sergio Mayordomo & Juan Ignacio Peña & Eduardo S. Schwartz, 2014. "Are All Credit Default Swap Databases Equal?," European Financial Management, European Financial Management Association, vol. 20(4), pages 677-713, September.
    4. Peter Feldhütter & Mads Stenbo Nielsen, 2012. "Systematic and Idiosyncratic Default Risk in Synthetic Credit Markets," The Journal of Financial Econometrics, Society for Financial Econometrics, vol. 10(2), pages 292-324, 2012 05.
    5. Carmen M. Reinhart & Kenneth S. Rogoff, 2009. "Varieties of Crises and Their Dates," Introductory Chapters, in: This Time Is Different: Eight Centuries of Financial Folly, Princeton University Press.
    6. Bryan Kelly & Ľuboš Pástor & Pietro Veronesi, 2016. "The Price of Political Uncertainty: Theory and Evidence from the Option Market," Journal of Finance, American Finance Association, vol. 71(5), pages 2417-2480, October.
    7. Bryan Kelly & Ľuboš Pástor & Pietro Veronesi, 2016. "The Price of Political Uncertainty: Theory and Evidence from the Option Market," Journal of Finance, American Finance Association, vol. 71(5), pages 2417-2480, October.
    8. Fabio Panetta & Thomas Faeh & Giuseppe Grande & Corrinne Ho & Michael R King & Aviram Levy & Federico M Signoretti & Marco Taboga & Andrea Zaghini, 2009. "An assessment of financial sector rescue programmes," BIS Papers, Bank for International Settlements, number 48.
    9. Paolo Angelini & Giuseppe Grande & Fabio Panetta, 2014. "The negative feedback loop between banks and sovereigns," Questioni di Economia e Finanza (Occasional Papers) 213, Bank of Italy, Economic Research and International Relations Area.
    10. Viral V. Acharya & Lasse H. Pedersen & Thomas Philippon & Matthew Richardson, 2017. "Measuring Systemic Risk," Review of Financial Studies, Society for Financial Studies, vol. 30(1), pages 2-47.
    11. Ricardo Correa & Kuan‐Hui Lee & Horacio Sapriza & Gustavo A. Suarez, 2014. "Sovereign Credit Risk, Banks' Government Support, and Bank Stock Returns around the World," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 46(s1), pages 93-121, February.
    12. repec:fip:fedhpr:y:2010:i:may:p:65-71 is not listed on IDEAS
    13. Harrison, J. Michael & Kreps, David M., 1979. "Martingales and arbitrage in multiperiod securities markets," Journal of Economic Theory, Elsevier, vol. 20(3), pages 381-408, June.
    14. Francis A. Longstaff & Sanjay Mithal & Eric Neis, 2005. "Corporate Yield Spreads: Default Risk or Liquidity? New Evidence from the Credit Default Swap Market," Journal of Finance, American Finance Association, vol. 60(5), pages 2213-2253, October.
    15. Nicola Gennaioli & Alberto Martin & Stefano Rossi, 2014. "Sovereign Default, Domestic Banks, and Financial Institutions," Journal of Finance, American Finance Association, vol. 69(2), pages 819-866, April.
    16. Reinhart, Karmen & Rogoff, Kenneth, 2009. ""This time is different": panorama of eight centuries of financial crises," Economic Policy, Russian Presidential Academy of National Economy and Public Administration, vol. 1, pages 77-114, March.
    17. Lubos Pástor & Pietro Veronesi, 2012. "Uncertainty about Government Policy and Stock Prices," Journal of Finance, American Finance Association, vol. 67(4), pages 1219-1264, August.
    18. Eichengreen, Barry & Mody, Ashoka & Nedeljkovic, Milan & Sarno, Lucio, 2012. "How the Subprime Crisis went global: Evidence from bank credit default swap spreads," Journal of International Money and Finance, Elsevier, vol. 31(5), pages 1299-1318.
    19. Zinna, Gabriele, 2013. "Sovereign default risk premia: Evidence from the default swap market," Journal of Empirical Finance, Elsevier, vol. 21(C), pages 15-35.
    20. Francis A. Longstaff & Jun Pan & Lasse H. Pedersen & Kenneth J. Singleton, 2011. "How Sovereign Is Sovereign Credit Risk?," American Economic Journal: Macroeconomics, American Economic Association, vol. 3(2), pages 75-103, April.
    21. Viral V. Acharya & Philipp Schnabl, 2010. "Do Global Banks Spread Global Imbalances? The Case of Asset-Backed Commercial Paper During the Financial Crisis of 2007-09," NBER Working Papers 16079, National Bureau of Economic Research, Inc.
    22. Gregory R. Duffee, 2002. "Term Premia and Interest Rate Forecasts in Affine Models," Journal of Finance, American Finance Association, vol. 57(1), pages 405-443, February.
    23. Viral V. Acharya & Raghuram G. Rajan, 2013. "Sovereign Debt, Government Myopia, and the Financial Sector," Review of Financial Studies, Society for Financial Studies, vol. 26(6), pages 1526-1560.
    24. Billio, Monica & Getmansky, Mila & Lo, Andrew W. & Pelizzon, Loriana, 2012. "Econometric measures of connectedness and systemic risk in the finance and insurance sectors," Journal of Financial Economics, Elsevier, vol. 104(3), pages 535-559.
    25. Joost Driessen, 2005. "Is Default Event Risk Priced in Corporate Bonds?," Review of Financial Studies, Society for Financial Studies, vol. 18(1), pages 165-195.
    26. Junye Li & Gabriele Zinna, 2014. "On bank credit risk: systemic or bank-specific? Evidence from the US and UK," Temi di discussione (Economic working papers) 951, Bank of Italy, Economic Research and International Relations Area.
    27. Bernanke, B.S., 2011. "International capital flows and the returns to safe assets in the United States 2003-2007," Financial Stability Review, Banque de France, issue 15, pages 13-26, February.
    28. Lars Peter Hansen, 2013. "Challenges in Identifying and Measuring Systemic Risk," NBER Chapters, in: Risk Topography: Systemic Risk and Macro Modeling, pages 15-30, National Bureau of Economic Research, Inc.
    29. Robert F. Dittmar, 2008. "Do Sovereign Bonds Benefit Corporate Bonds in Emerging Markets?," Review of Financial Studies, Society for Financial Studies, vol. 21(5), pages 1983-2014, September.
    30. Noss, Joseph & Sowerbutts, Rhiannon, 2012. "Financial Stability Paper No 15: The implicit subsidy of banks," Bank of England Financial Stability Papers 15, Bank of England.
    31. Carmen M. Reinhart & Kenneth S. Rogoff, 2014. "This Time is Different: A Panoramic View of Eight Centuries of Financial Crises," Annals of Economics and Finance, Society for AEF, vol. 15(2), pages 215-268, November.
    32. Black, Lamont & Correa, Ricardo & Huang, Xin & Zhou, Hao, 2016. "The systemic risk of European banks during the financial and sovereign debt crises," Journal of Banking & Finance, Elsevier, vol. 63(C), pages 107-125.
    33. Pástor, Ľuboš & Veronesi, Pietro, 2013. "Political uncertainty and risk premia," Journal of Financial Economics, Elsevier, vol. 110(3), pages 520-545.
    34. Duffie, Darrell & Singleton, Kenneth J, 1999. "Modeling Term Structures of Defaultable Bonds," Review of Financial Studies, Society for Financial Studies, vol. 12(4), pages 687-720.
    35. Michael D. Bauer & Glenn D. Rudebusch & Jing Cynthia Wu, 2012. "Correcting Estimation Bias in Dynamic Term Structure Models," Journal of Business & Economic Statistics, Taylor & Francis Journals, vol. 30(3), pages 454-467, April.
    36. Dimitrios Bisias & Mark Flood & Andrew W. Lo & Stavros Valavanis, 2012. "A Survey of Systemic Risk Analytics," Annual Review of Financial Economics, Annual Reviews, vol. 4(1), pages 255-296, October.
    37. Darrell Duffie & Jun Pan & Kenneth Singleton, 2000. "Transform Analysis and Asset Pricing for Affine Jump-Diffusions," Econometrica, Econometric Society, vol. 68(6), pages 1343-1376, November.
    38. Ang, Andrew & Longstaff, Francis A., 2013. "Systemic sovereign credit risk: Lessons from the U.S. and Europe," Journal of Monetary Economics, Elsevier, vol. 60(5), pages 493-510.
    39. González-Hermosillo, Brenda & Johnson, Christian, 2017. "Transmission of financial stress in Europe: The pivotal role of Italy and Spain, but not Greece," Journal of Economics and Business, Elsevier, vol. 90(C), pages 49-64.
    40. Jeremy C. Stein & Anil K. Kashyap, 2000. "What Do a Million Observations on Banks Say about the Transmission of Monetary Policy?," American Economic Review, American Economic Association, vol. 90(3), pages 407-428, June.
    41. Fabian Lindner, 2013. "Banken treiben Eurokrise," IMK Report 82-2013, IMK at the Hans Boeckler Foundation, Macroeconomic Policy Institute.
    42. Luc Laeven & Lev Ratnovski & Hui Tong, 2014. "Bank Size and Systemic Risk," IMF Staff Discussion Notes 14/4, International Monetary Fund.
    43. Jun Pan & Kenneth J. Singleton, 2008. "Default and Recovery Implicit in the Term Structure of Sovereign CDS Spreads," Journal of Finance, American Finance Association, vol. 63(5), pages 2345-2384, October.
    44. Bryan J. Noeth & Rajdeep Sengupta, 2012. "Global European banks and the financial crisis," Review, Federal Reserve Bank of St. Louis, issue Nov, pages 457-480.
    45. Markus K. Brunnermeier, 2009. "Deciphering the Liquidity and Credit Crunch 2007-2008," Journal of Economic Perspectives, American Economic Association, vol. 23(1), pages 77-100, Winter.
    46. Nicola Cetorelli & Linda S. Goldberg, 2012. "Banking Globalization and Monetary Transmission," Journal of Finance, American Finance Association, vol. 67(5), pages 1811-1843, October.
    47. Francis A. Longstaff & Arvind Rajan, 2008. "An Empirical Analysis of the Pricing of Collateralized Debt Obligations," Journal of Finance, American Finance Association, vol. 63(2), pages 529-563, April.
    48. Cheridito, Patrick & Filipovic, Damir & Kimmel, Robert L., 2007. "Market price of risk specifications for affine models: Theory and evidence," Journal of Financial Economics, Elsevier, vol. 83(1), pages 123-170, January.
    49. Mr. Luc Laeven & Mr. Lev Ratnovski & Mr. Hui Tong, 2014. "Bank Size and Systemic Risk," IMF Staff Discussion Notes 2014/004, International Monetary Fund.
    50. Viral V Acharya & Philipp Schnabl, 2010. "Do Global Banks Spread Global Imbalances? Asset-Backed Commercial Paper during the Financial Crisis of 2007–09," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 58(1), pages 37-73, August.
    51. Giglio, Stefano & Kelly, Bryan & Pruitt, Seth, 2016. "Systemic risk and the macroeconomy: An empirical evaluation," Journal of Financial Economics, Elsevier, vol. 119(3), pages 457-471.
    52. Mr. Christian A Johnson & Ms. Brenda Gonzalez-Hermosillo, 2014. "Transmission of Financial Stress in Europe: The Pivotal Role of Italy and Spain, but not Greece," IMF Working Papers 2014/076, International Monetary Fund.
    53. Anil K. Kashyap & Jeremy C. Stein, 2004. "Cyclical implications of the Basel II capital standards," Economic Perspectives, Federal Reserve Bank of Chicago, vol. 28(Q I), pages 18-31.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Mäkinen, Taneli & Sarno, Lucio & Zinna, Gabriele, 2020. "Risky bank guarantees," Journal of Financial Economics, Elsevier, vol. 136(2), pages 490-522.
    2. Sergio Masciantonio & Andrea Zaghini, 2017. "Systemic risk and systemic importance measures during the crisis," Temi di discussione (Economic working papers) 1153, Bank of Italy, Economic Research and International Relations Area.
    3. Gabriella CHIESA & José Manuel MANSILLA-FERNÁNDEZ, 2018. "Non-Performing Loans, Cost of Capital, and Lending Supply: Lessons from the Eurozone Banking Crisis," Departmental Working Papers 2018-05, Department of Economics, Management and Quantitative Methods at Università degli Studi di Milano.
    4. Iryna Kaminska & Gabriele Zinna, 2020. "Official Demand for U.S. Debt: Implications for U.S. Real Rates," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 52(2-3), pages 323-364, March.
    5. Stefano Neri & Stefano Siviero, 2018. "The Non-Standard Monetary Policy Measures of the ECB: Motivations, Effectiveness and Risks," Credit and Capital Markets, Credit and Capital Markets, vol. 51(4), pages 513-560.
    6. María Cantero Sáiz & Sergio Sanfilippo Azofra & Begoña Torre Olmo, 2019. "The single supervision mechanism and contagion between bank and sovereign risk," Journal of Regulatory Economics, Springer, vol. 55(1), pages 67-106, February.
    7. G. Chiesa & J. M. Mansilla-Fernández, 2018. "Non-Performing Loans, Cost of Capital, and Lending Supply: Lessons from the Eurozone Banking Crisi," Working Papers wp1124, Dipartimento Scienze Economiche, Universita' di Bologna.
    8. Xisong Jin & Francisco Nadal De Simone, 2017. "Systemic Financial Sector and Sovereign Risks," BCL working papers 109, Central Bank of Luxembourg.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Junye Li & Gabriele Zinna, 2018. "How Much of Bank Credit Risk Is Sovereign Risk? Evidence from Europe," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 50(6), pages 1225-1269, September.
    2. Augustin, Patrick & Subrahmanyam, Marti G. & Tang, Dragon Yongjun & Wang, Sarah Qian, 2014. "Credit Default Swaps: A Survey," Foundations and Trends(R) in Finance, now publishers, vol. 9(1-2), pages 1-196, December.
    3. Zinna, Gabriele, 2013. "Sovereign default risk premia: Evidence from the default swap market," Journal of Empirical Finance, Elsevier, vol. 21(C), pages 15-35.
    4. Jian Luo & Xiaoxia Ye & May Hu, 2016. "Counter-Credit-Risk Yield Spreads: A Puzzle in China's Corporate Bond Market," International Review of Finance, International Review of Finance Ltd., vol. 16(2), pages 203-241, June.
    5. Moratis, Georgios & Sakellaris, Plutarchos, 2021. "Measuring the systemic importance of banks," Journal of Financial Stability, Elsevier, vol. 54(C).
    6. Kallestrup, René & Lando, David & Murgoci, Agatha, 2016. "Financial sector linkages and the dynamics of bank and sovereign credit spreads," Journal of Empirical Finance, Elsevier, vol. 38(PA), pages 374-393.
    7. Viral Acharya & Itamar Drechsler & Philipp Schnabl, 2014. "A Pyrrhic Victory? Bank Bailouts and Sovereign Credit Risk," Journal of Finance, American Finance Association, vol. 69(6), pages 2689-2739, December.
    8. Jeanneret, Alexandre & Souissi, Slim, 2016. "Sovereign defaults by currency denomination," Journal of International Money and Finance, Elsevier, vol. 60(C), pages 197-222.
    9. Jeanneret, Alexandre, 2018. "Sovereign credit spreads under good/bad governance," Journal of Banking & Finance, Elsevier, vol. 93(C), pages 230-246.
    10. Nadal De Simone, Francisco, 2021. "Measuring the deadly embrace: Systemic and sovereign risks," Research in International Business and Finance, Elsevier, vol. 56(C).
    11. Brunnermeier, Markus K. & Oehmke, Martin, 2013. "Bubbles, Financial Crises, and Systemic Risk," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, volume 2, chapter 0, pages 1221-1288, Elsevier.
    12. Kräussl, Roman & Lehnert, Thorsten & Stefanova, Denitsa, 2016. "The European sovereign debt crisis: What have we learned?," Journal of Empirical Finance, Elsevier, vol. 38(PA), pages 363-373.
    13. Sedunov, John, 2021. "Federal reserve intervention and systemic risk during financial crises," Journal of Banking & Finance, Elsevier, vol. 133(C).
    14. Sara Cecchetti, 2019. "A Quantitative Analysis of Risk Premia in the Corporate Bond Market," JRFM, MDPI, vol. 13(1), pages 1-33, December.
    15. Alessandri, Piergiorgio & Masciantonio, Sergio & Zaghini, Andrea, 2014. "Everything you always wanted to know about systemic importance (but were afraid to ask)," CFS Working Paper Series 463, Center for Financial Studies (CFS).
    16. Gerardo Manzo & Antonio Picca, 2020. "The Impact of Sovereign Shocks," Management Science, INFORMS, vol. 66(7), pages 3113-3132, July.
    17. Dungey, Mardi & Harvey, John & Volkov, Vladimir, 2019. "The changing international network of sovereign debt and financial institutions," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 60(C), pages 149-168.
    18. Ebrahimi Kahou, Mahdi & Lehar, Alfred, 2017. "Macroprudential policy: A review," Journal of Financial Stability, Elsevier, vol. 29(C), pages 92-105.
    19. Kizys, Renatas & Paltalidis, Nikos & Vergos, Konstantinos, 2016. "The quest for banking stability in the euro area: The role of government interventions," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 40(C), pages 111-133.
    20. Morais, Bernardo & Peydró, José-Luis & Roldán Peña, Jessica & Ruiz Ortega, Claudia, 2019. "The International Bank Lending Channel of Monetary Policy Rates and QE: Credit Supply, Reach-for-Yield, and Real Effects," EconStor Open Access Articles and Book Chapters, ZBW - Leibniz Information Centre for Economics, pages 55-90.

    More about this item

    Keywords

    Sovereign and Bank Credit Risk; Credit Default Swaps; Distress Risk Premia; Bayesian Estimation.;
    All these keywords.

    JEL classification:

    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:bdi:wptemi:td_990_14. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: . General contact details of provider: https://edirc.repec.org/data/bdigvit.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (email available below). General contact details of provider: https://edirc.repec.org/data/bdigvit.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.