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The Feedback Loop between the Sovereign and Banking Sector Credit Risk in Europe

The relation between sovereign and banking sector credit risk has raised a lot of concerns in the last decade. The interconnectedness among these two sectors can be studied from different perspectives. This paper has mainly considered this link structured as a loop in which the credit risk can circulate from a sector to the other and then back again. In particular, in the model here engaged, the financial crisis has caused a shock in the sovereign CDS market. Through the bailout measure employed by governments in Europe the credit risk has been transferred from the banking sector to the sovereign sector. The increase in sovereign credit risk has caused, on its turn, an increase in the banking sector CDS which can be explained with several channels. […]