Abstract:
This study examines the nexus between sovereigns and banks during a crisis
with a focus on the effects of PSI, the voluntary exchange program of Greek
sovereign bonds with private sector involvement. The effectiveness of the
program is evaluated through its impact on credit default swaps of 8 Eurozone
countries and 21 banks, using daily data from 2009 to 2014. Using linear and
nonlinear causality analyses, it is found that the link between sovereign and
bank risk weakened after PSI, while the persistence and magnitude of lead-lag
interactions also declined in the same period. A difference-in-difference model
confirms this result. The findings are also robust to second moment filtering,
with GARCH-BEKK residuals indicating the presence of significant albeit
declining nonlinear causal effects. The empirical evidence suggests that
sovereign debt restructuring initiatives, such as PSI, could be an effective policy
measure to ease off pressure on the nexus between banks and their sovereigns.
