Systemic risk and financial stability dynamics during the Eurozone debt crisis

Based on the twin sovereign-banking crisis nexus evolution of the Euro debt crisis era, we address the (volatility) mitigation of credit risk, measured by Credit Default Swap spreads (CDS) in both the banking and sovereign sectors within the Eurozone and the US/UK. Secondly, we highlight the volatility interconnectedness or the risk pass-through between sovereign-bank CDS markets with reference to the core vs. periphery EMU. Moreover, we identify the regime states of crises and recovery periods based on the bivariate CDS dynamic correlation series, categorized as the endogenous EMU sovereign risk coherence index. Finally, we investigate the “efficient” (parity) sovereign credit risk pricing during the post-crisis spillover period identified by the CDS and bond markets. We find heterogeneity between markets in pricing the sovereign risk in the regional tier (core-periphery EMU), emphasized by the absence of long-term association. Cointegration results are country-dependent as well as maturity-dependent. Empirical results reject the “no arbitrage” approach.