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Transmission of Sovereign Risk in the Euro Crisis

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We assess the role of financial linkages for the transmission of sovereign risk in the Euro Crisis. Building on the narrative approach by Romer and Romer (1989), we use financial news to identify structural shocks in a VAR model of daily sovereign CDS for eleven European countries. To estimate how these shocks transmit across borders, we use data on cross-country bank exposures to sovereign debt. Our results indicate that exposure to Greek sovereign debt and debt of Greek banks constitute important transmission channels. Overall, financial linkages explain up to two thirds of transmission of sovereign debt in the Euro Crisis.

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Paper provided by Swiss National Bank, Study Center Gerzensee in its series Working Papers with number 12.01.

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Length: 46 pages
Date of creation: Jan 2012
Handle: RePEc:szg:worpap:1201
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