Credit Contagion and Risk Sharing among State Governments

Abstract

We investigate how the negative credit events of a state can affect the credit risk of other states as well as the channels of state credit-risk spillover in the U.S. We find that one state’s credit rating downgrades and credit default swap jumps have a contagion effect on the credit risk of other states. In contrast, a negative credit outlook can introduce credit competition to non-event states. Additionally, risk sharing via capital markets and federal government are two crucial channels on the spillover effects. Industry similarity, political connections, and geographical proximity could affect the size of the interstate spillovers. Key words: State credit events, risk sharing, capital market, credit market, federal government