Dissecting the ‘doom loop’: the bank-sovereign credit risk nexus during the US debt ceiling crisis

Gori, Filippo (2019): Dissecting the ‘doom loop’: the bank-sovereign credit risk nexus during the US debt ceiling crisis.

Abstract

Political events matter in economics. This paper uses the 2011 political stando� over the rise of the US debt ceiling to characterise an instrument that is then used to estimate the impact of sovereigns' on bank credit risk. Results show that a 100 basis points increase in US sovereign default risk produces a 41 basis points increase in bank credit risk; this e�ect is about three times larger than the corresponding e�ect of bank default risk on sovereigns'. Finally, calculations suggest that during the �rst two quarters of 2011, as a consequence of the debt ceiling crisis, US bank funding costs increased by approximately 18 basis points.

• Item Type: MPRA Paper
• Language: English
• Keywords: Banks, Sovereign default risk
• Subjects: G - Financial Economics > G1 - General Financial Markets > G18 - Government Policy and Regulation; G - Financial Economics > G2 - Financial Institutions and Services > G21 - Banks ; Depository Institutions ; Micro Finance Institutions ; Mortgages; G - Financial Economics > G2 - Financial Institutions and Services > G28 - Government Policy and Regulation

References

Acharya, V., Drechsler, I., Schnabl, P., 2014. A pyrrhic victory? bank bailouts and sovereign credit risk. The Journal of Finance 69, 2689–2739.

Acharya, V.V., Eisert, T., Eufinger, C., Hirsch, C., 2018. Real effects of the sovereign debt crisis in europe: Evidence from syndicated loans. The Review of Financial Studies 31, 2855–2896.

Albertazzi, U., Ropele, T., Sene, G., Signoretti, F.M., 2014. The impact of the sovereign debt crisis on the activity of italian banks. Journal of Banking & Finance 46, 387–402.

Altavilla, C., Pagano, M., Simonelli, S., 2017. Bank exposures and sovereign stress transmission. Review of Finance 21, 2103–2139.

Alter, A., Beyer, A., 2014. The dynamics of spillover effects during the european sovereign debt turmoil. Journal of Banking & Finance 42, 134– 153.

Alter, A., Schu ̈ler, Y.S., 2012. Credit spread interdependencies of european states and banks during the financial crisis. Journal of Banking & Finance 36, 3444–3468.

Becker, B., Ivashina, V., 2017. Financial repression in the european sovereign debt crisis. Review of Finance 22, 83–115.

Brunnermeier, M.K., Garicano, L., Lane, P.R., Pagano, M., Reis, R., Santos, T., Thesmar, D., Van Nieuwerburgh, S., Vayanos, D., 2016. The sovereign- bank diabolic loop and esbies. American Economic Review 106, 508–12.

Cooper, R., Nikolov, K., 2013. Government debt and banking fragility: The spreading of strategic uncertainty. Technical Report. National Bureau of Economic Research.

De Bruyckere, V., Gerhardt, M., Schepens, G., Vander Vennet, R., 2013. Bank/sovereign risk spillovers in the european debt crisis. Journal of Banking & Finance 37, 4793–4809.

De Marco, F., 2017. Bank lending and the european sovereign debt crisis. Journal of Financial and Quantitative Analysis forthcoming.

Duffie, D., 1999. Credit swap valuation. Financial Analysts Journal 55, 73–87.

Farhi, E., Tirole, J., 2016. Deadly embrace: Sovereign and financial bal- ance sheets doom loops. Technical Report. National Bureau of Economic Research.

Gennaioli, N., Martin, A., Rossi, S., 2014. Sovereign default, domestic banks, and financial institutions. The Journal of Finance 69, 819–866.

Hausman, J.A., Newey, W.K., Taylor, W.E., 1987. Efficient estimation and identification of simultaneous equation models with covariance restric- tions. Econometrica: Journal of the Econometric Society , 849–874.

Hausman, J.A., Taylor, W.E., 1983. Identification in linear simultaneous equations models with covariance restrictions: an instrumental variables interpretation. Econometrica: Journal of the Econometric Society , 1527– 1549.

Houweling, P., Vorst, T., 2002. An empirical comparison of default swap pricing models. Unpublished manuscript .

Hull, J.C., White, A., 2000. Valuing credit default swaps i: No counterparty default risk .

Lahiri, K., Schmidt, P., 1978. On the estimation of triangular structural systems. Econometrica: Journal of the Econometric Society , 1217–1221.

Leonello, A., et al., 2014. Government guarantees and the two-way feedback between banking and sovereign debt crises. Unpublished working paper.

Popov, A., Van Horen, N., 2013. The impact of sovereign debt exposure on bank lending: Evidence from the European debt crisis. Technical Report. Netherlands Central Bank, Research Department.

Zoli, M.E., 2013. Italian sovereign spreads: Their determinants and pass- through to bank funding costs and lending conditions. 13-84, International Monetary Fund.