Abstract
We characterize the debt risk and bank risk of local governments in China with a dynamic factor model that decomposes 31 provincial data of China into country, regional, and idiosyncratic components. The result shows the presence of co-movement between local government debt risk and bank risk. The country, regional, and province factors explain 62%, 16%, and 22% of local government debt risk, respectively, and 28%, 8%, and 64% of commercial bank risk, respectively. Sub-sample analysis reveals that the country factor has become less volatile and its importance typically increases across all provinces after the reform of local government debt financing pattern (e.g., the introduction of Document No. 43).
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