Sovereign - Bank Default Risk Linkages During the Greek Financial Crisis and the Role of the Italian Debt

Abstract

The Greek crisis has brought to light the strong nexus between the credit risks of European banks and their sovereign. We study this phenomenon in Germany, France, Italy and Spain by estimating the conditional correlations between sovereign and bank CDS bond spreads over the period 2006-2015. Trivariate time-varying regime switching correlation analyses, such as the STCC-GARCH and DSTCC-GARCH, are implemented to associate causally the state shifts to the dynamics of the so-called “transition variables”. We find evidence of significant changes in the correlation structures due to the evolution of both the Greek and Italian crises.