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Systemic Risk in the European Union: A Network Approach to Banks’ Sovereign Debt Exposures

School of Economics, Management, and Statistics, University of Bologna, 40126 Bologna, Italy
Academic Editors: Marida Bertocchi and Rita L. D’Ecclesia
Int. J. Financial Stud. 2015, 3(3), 244-279; https://doi.org/10.3390/ijfs3030244
Received: 31 March 2015 / Revised: 4 July 2015 / Accepted: 13 July 2015 / Published: 23 July 2015
This paper draws on network theory to investigate European banks’ sovereign debt exposures. Banks’ holdings of sovereign debt build a network of financial linkages with European countries that exhibits a long-tail distribution of node degrees. A highly connected network core of 15 banks is identified. These banks accounted for the majority of sovereign debt investments between December 2010 and December 2013 but exhibited only average and sometimes even below average capitalizations. Consequently, they constituted a potential source and transmission channel of systemic risk, especially due to their proneness to portfolio contagion. In a complementary regression analysis, the effect of counterparty risk on Credit Default Swap (CDS) spreads of 15 EU sovereigns is investigated. Among the banks exposed to the debt of a particular issuer, the biggest institutions in terms of their own asset sizes are identified and some of their balance sheet characteristics included into the regression. The analysis finds that the banks’ implied volatilities had a significant and increasing effect on CDS spreads during the recent crisis years, providing evidence of the presence of counterparty risk and its effect on EU sovereign debt pricing. Furthermore, the role of the domestic financial sectors is assessed and found to have affected the CDS spreads. View Full-Text
Keywords: contagion; sovereign risk; European debt; European banks; stress tests contagion; sovereign risk; European debt; European banks; stress tests
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Westphal, A. Systemic Risk in the European Union: A Network Approach to Banks’ Sovereign Debt Exposures. Int. J. Financial Stud. 2015, 3, 244-279.

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