A Market-based Approach to Sector Risk Determinants and Transmission in the Euro Area

Abstract

In a panel data framework applied to Portfolio Distance-to-Default series of corporate sectors in the euro area, this paper evaluates systemic and idiosyncratic determinants of default risk and examines how distress is transferred in and between the financial and corporate sectors since the early days of the euro. This approach takes into account observed and unobserved common factors and the presence of different degrees of cross-section dependence in the form of economic proximity. This paper contributes to the financial stability literature with a contingent claims approach to a sector-based analysis with a less dominant macro focus while being compatible with existing stress-testing methodologies in the literature. A disaggregated analysis of the different corporate and financial sectors allows for a more detailed assessment of specificities in terms of risk pro le, i.e. heterogeneity of business models, risk exposures and interaction with the rest of the macro environment.