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The quest for banking stability in the euro area: the role of government interventions

The quest for banking stability in the euro area: the role of government interventions
The quest for banking stability in the euro area: the role of government interventions
We build upon a Markov-Switching Bayesian Vector Autoregression (MSBVAR) model to study how the credit default swaps market in the euro area becomes an important chain in the propagation of shocks through the entire financial system. The study sheds light on the regime-dependent interconnectedness between the risk of investing in banking and public sector bonds and provides novel evidence that a rise in sovereign debt, due to the countercyclical fiscal policy measures, is perceived by stock market investors as a burden on growth prospects. We also document that government interventions in the banking sector deteriorate the credit risk of sovereign debt. Higher risk premium required by investors for holding riskier government bonds depresses the sovereign debt market, it impairs banks’ balance sheets, and it depresses the collateral value of loans leading to bank retrenchment. The ensuing two-way banking-fiscal feedback loop indicates that government interventions do not necessarily stabilize the banking sector.
Banking stability, Credit default swaps, Government interventions, Markov Switching Bayesian Vector Autoregression, Sovereign debt, Stock market
1042-4431
111-133
Kizys, Renatas
9d3a6c5f-075a-44f9-a1de-32315b821978
Paltalidis, Nikos
21f9fcb7-d63e-4ce0-ba01-d312593e49ef
Vergos, Konstantinos
50475a8c-0ba4-4e73-9d11-bea23e901712
Kizys, Renatas
9d3a6c5f-075a-44f9-a1de-32315b821978
Paltalidis, Nikos
21f9fcb7-d63e-4ce0-ba01-d312593e49ef
Vergos, Konstantinos
50475a8c-0ba4-4e73-9d11-bea23e901712

Kizys, Renatas, Paltalidis, Nikos and Vergos, Konstantinos (2015) The quest for banking stability in the euro area: the role of government interventions. Journal of International Financial Markets, Institutions and Money, 40, 111-133. (doi:10.1016/j.intfin.2015.09.001).

Record type: Article

Abstract

We build upon a Markov-Switching Bayesian Vector Autoregression (MSBVAR) model to study how the credit default swaps market in the euro area becomes an important chain in the propagation of shocks through the entire financial system. The study sheds light on the regime-dependent interconnectedness between the risk of investing in banking and public sector bonds and provides novel evidence that a rise in sovereign debt, due to the countercyclical fiscal policy measures, is perceived by stock market investors as a burden on growth prospects. We also document that government interventions in the banking sector deteriorate the credit risk of sovereign debt. Higher risk premium required by investors for holding riskier government bonds depresses the sovereign debt market, it impairs banks’ balance sheets, and it depresses the collateral value of loans leading to bank retrenchment. The ensuing two-way banking-fiscal feedback loop indicates that government interventions do not necessarily stabilize the banking sector.

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KIZYS_2015_cright_JIFMIM_The_quest_for_financial_stability_in_the_euro_area - Accepted Manuscript
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Accepted/In Press date: 14 September 2015
e-pub ahead of print date: 25 September 2015
Keywords: Banking stability, Credit default swaps, Government interventions, Markov Switching Bayesian Vector Autoregression, Sovereign debt, Stock market

Identifiers

Local EPrints ID: 434027
URI: http://eprints.soton.ac.uk/id/eprint/434027
ISSN: 1042-4431
PURE UUID: 6deff07d-e3c5-47df-b703-9b6fff7f7cfe
ORCID for Renatas Kizys: ORCID iD orcid.org/0000-0001-9104-1809

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Date deposited: 11 Sep 2019 16:30
Last modified: 08 Jan 2022 03:39

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Contributors

Author: Renatas Kizys ORCID iD
Author: Nikos Paltalidis
Author: Konstantinos Vergos

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