How Much of Bank Credit Risk is Sovereign Risk? Evidence from the Eurozone
78 Pages Posted: 28 Feb 2015
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How Much of Bank Credit Risk Is Sovereign Risk? Evidence from Europe
Date Written: October 23, 2014
Abstract
We develop a multivariate credit risk model for the term structures of sovereign and bank credit default swaps. First, we separate the probability of joint defaults of large Eurozone sovereigns (systemic risk) from that of sovereign-specific defaults (country risk). Then, we quantify individual banks' exposures to each type of sovereign risk, as well as bank-specific credit risk. Banks’ sovereign risk exposures vary with banks’ size, their holdings of sovereign debt, and expected government support. On average, 45% of French and Spanish banks' credit risk consists in sovereign risk, compared with only 30% for Italian and 23% for German banks. Furthermore, short- to medium-term contracts are particularly informative on sovereign systemic risk.
Keywords: Sovereign and Bank Credit Risk, Credit Default Swaps, Distress Risk Premia, Bayesian Estimation
JEL Classification: F34, G12, G15
Suggested Citation: Suggested Citation