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Bank and sovereign debt risk connection

Author

Listed:
  • Darracq Pariès, Matthieu
  • Faia, Ester
  • Rodriguez Palenzuela, Diego

Abstract

Euro area data show a positive connection between sovereign and bank risk, which increases with banks' and sovereign long run fragility. We build a macro model with banks subject to moral hazard and liquidity risk (sudden deposit withdrawals): banks invest in risky government bonds as a form of capital buffer against liquidity risk. The model can replicate the positive connection between sovereign and bank risk observed in the data. Central bank liquidity policy, through full allotment policy, is successful in stabilizing the spiraling feedback loops between bank and sovereign risk.

Suggested Citation

  • Darracq Pariès, Matthieu & Faia, Ester & Rodriguez Palenzuela, Diego, 2013. "Bank and sovereign debt risk connection," SAFE Working Paper Series 7, Leibniz Institute for Financial Research SAFE, revised 2013.
    • Handle: RePEc:zbw:safewp:7
    DOI: 10.2139/ssrn.2228494
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    References listed on IDEAS

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    Cited by:

    1. Oleg Deev & Martin Hodula, 2016. "Sovereign default risk and state-owned bank fragility in emerging markets: evidence from China and Russia," Post-Communist Economies, Taylor & Francis Journals, vol. 28(2), pages 232-248, April.

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    JEL classification:

    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • G3 - Financial Economics - - Corporate Finance and Governance
    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook

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