The effect of the PSI in the relationship between sovereign and bank credit risk: Evidence from the Euro Area

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

Interdependence between Sovereign and Bank CDS Spreads in Eurozone during the European Debt Crisis - The PSI Effect

This paper examines the changes in the interdependence between sovereign and bank credit risk, that were noticed, after the announcement of the voluntary exchange program of Greek bonds, with the participation of the private sector (Private Sector Involvement - PSI). More precisely, we investigate the progress of the credit default swaps (CDS) of eight eurozone countries and of twenty-one banking institutions, for the period of January 2009 to May 2014. We divide the sample into two sub-periods, based on the announcement of the program. We apply Hsiao's methodology (1981), in order to ascertain the causality which is observed between the CDS series and potential changes in their relationship, due to the implementation of the PSI. We identify limited causality relations between countries and banks of the sample examined, in the second sub-period, while the size of the interaction is reduced in the same period. After developing a Difference-in-Difference model, we confirm the weakening of causal relationships between the CDS series studied, for the period, after the announcement of the PSI. Our results suggest that the implementation of the PSI has contributed to the limitation of the interdependence between the CDS spreads of the sovereigns and banks in the period that follows