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Avoiding the fall into the loop: Isolating the transmission of bank-to-sovereign distress in the euro area and its drivers

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  • Böhm, Hannes
  • Eichler, Stefan

Abstract

We isolate the direct bank-to-sovereign distress channel within the eurozone's sovereign-bank-loop by exploiting the global, non-eurozone related variation in stock prices. We instrument banking sector stock returns in the eurozone with exposure-weighted stock market returns from non-eurozone countries and take further precautions to remove any eurozone crisis-related variation. We find that the transmission of instrumented bank distress, while economically relevant, is significantly smaller than the corresponding coefficient in the unadjusted OLS framework, confirming concerns on reverse causality and omitted variables in previous studies. Furthermore, we show that the spillover of bank distress is significantly stronger for countries with poorer macroeconomic performances, weaker financial sectors and financial regulation and during times of elevated political uncertainty.

Suggested Citation

  • Böhm, Hannes & Eichler, Stefan, 2018. "Avoiding the fall into the loop: Isolating the transmission of bank-to-sovereign distress in the euro area and its drivers," IWH Discussion Papers 19/2018, Halle Institute for Economic Research (IWH).
  • Handle: RePEc:zbw:iwhdps:192018
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    References listed on IDEAS

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    More about this item

    Keywords

    sovereign-bank-loop; bank distress; instrumental variable estimation; bank exposures; macroeconomic performance;
    All these keywords.

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • F3 - International Economics - - International Finance
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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