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

Kizys, R.; Paltalidis, N.; Vergos, K.

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Authors

R. Kizys

K. Vergos



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.

Citation

Kizys, R., Paltalidis, N., & Vergos, K. (2016). 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. https://doi.org/10.1016/j.intfin.2015.09.001

Journal Article Type Article
Acceptance Date Sep 14, 2015
Online Publication Date Sep 25, 2015
Publication Date Jan 1, 2016
Deposit Date Oct 2, 2015
Publicly Available Date Sep 25, 2016
Journal Journal of International Financial Markets, Institutions and Money
Print ISSN 1042-4431
Publisher Elsevier
Peer Reviewed Peer Reviewed
Volume 40
Pages 111-133
DOI https://doi.org/10.1016/j.intfin.2015.09.001
Keywords Banking Stability, Credit Default Swaps, Government Interventions, Markov Switching Bayesian Vector Autoregression, Sovereign Debt, Stock Market.
Public URL https://durham-repository.worktribe.com/output/1398774

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