Systemic risk and the sovereign-bank default nexus: a network vector autoregression approach

Abstract

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Using the generalized value-at-risk method of Diebold and Yilmaz in their 2009 paper "Measuring financial asset return and volatility spillovers, with application to global equity markets" to measure the degree of spillover, we propose a metric for the systemic risk of a market. The metric considers the distribution of the impact to and from a market. This coskewness measure identifies key markets that play a central role in transmission across the market as a whole.We apply this method to detail the linkages between European Union (EU) sovereign bond markets and twenty major EU banks over time since 2000.We show that fiscal problems in Spain are transmitted via its internationally developed banking sector to the rest of Europe. This spillover has increased substantially since the outbreak of the crisis in the eurozone in May 2010. European Economic and Monetary Union-wide solutions have looked to stem the effects of ailing banking sectors and bad public finances as well as break the doom loop between banks and sovereigns. The creation of the European Financial Stability Facility and the European Stability Mechanism, in addition to European Central Bank action, has helped to decouple the situation of Spanish public finances from those of EU banks.