Analyzing credit risk transmission to the nonfinancial sector in Europe: A network approach

Abstract

SummaryWe use a factor model and elastic net shrinkage to model a high‐dimensional network of European credit default swap (CDS) spreads. Our empirical approach allows us to assess thejointtransmission of bank and sovereign risk to the nonfinancial corporate sector. Our findings identify a sectoral clustering in the CDS network, where financial institutions are in the center and nonfinancial entities as well as sovereigns are grouped around the financial center. The network has a geographical component reflected in different patterns of real‐sector risk transmission across countries. Our framework also provides dynamic estimates of risk transmission, a useful tool for systemic risk monitoring.