Journal of Network Theory in Finance

Credit risk spillover between financials and sovereigns in the euro area, 2007–15

Olivier Vergote

  • Contagion indices based on Granger causality need to control for common factors.
  • Contagion indices based on market CDS spreads tend to over-identify spillover.
  • Only the more intense crisis episodes saw credit risk contagion and feedback.
  • Sovereign-to-bank spillover normalised as policymakers took crisis measures
  • Governments are still found to provide implicit guarantees to financials.


This paper presents time-varying contagion indexes of credit risk spillover and feedback between sixty-four financials and sovereigns in the euro area, where spillover is identified based on bilateral Granger causality regressions. Over-identification of contagion between financials' true credit risk and sovereign credit risk is avoided (1) by controlling for common factors and (2) by relying on fair-value credit default swap spreads as the credit risk measure for financials. The results show that, in particular, the run-up to the financial crisis and the more intense phases of the crisis were associated with credit risk contagion and feedback. The institutions identified as most central to the network during those episodes are known to have played important roles during the crisis. Further, the tense periods were short-lived, and sovereign-to-bank spillover was found to normalize when policymakers took measures to stem the crisis. Finally, a proxy for the value of implicit government guarantees to the financial sector was still positive toward the end of the sample, suggesting the financial-sovereign nexus had not yet been removed by new bank resolution mechanisms and regulatory changes.

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