A non-linear analysis of the sovereign bank nexus in the EU

Abstract

We investigate the time varying dynamics of the linkages between sovereign and bank default risks over the period 2006–2015, using the credit default swap (CDS) spreads of the bonds of major banks and sovereign issuers in the EMU. The nexus between bank risk in core countries and sovereign risk of peripheral countries is also analyzed and found to be relevant. The use of a time-varying regime switching analysis, the STCC-GARCH, identifies the asymmetric impact of the economic variables behind the state shifts, the so-called “transition variables”. This approach also dates both the positive shifts in the size of the nexus that are due to financial shocks (viz. the Lehman crisis, the evolution of the Greek crisis) and the negative shifts that follow the implementation of unconventional monetary policy measures.