Assessing the sovereign-bank interdependence in Eurozone core countries

Purpose-The aim of this study is to determine whether financial contagion is transmitted through macroeconomic fundamentals, not only in weaker countries but also in strong European Monetary Union (EMU) economies. Design/methodology/approach-This study conducts, for the first time, an analysis of the spillover effects resulting from a shock to Italian sovereign risk on the banking systems and credit default swaps (CDS) of five EMU core countries during the period 2012-2018, employing a global vector autoregressive (GVAR) approach. Spatial interdependence is quantified through the cross-country distance in the deficit-to-gross domestic product (GDP) ratio. Findings-The findings reveal the existence of both a "doom-loop" between banks and sovereign bonds and a "bad neighbours" effect. The susceptibility to spillovers is notably higher in economies displaying a larger deficit-to-GDP ratio. These results suggest that differences in fiscal fundamentals could drive financial contagion even within core countries, indicating a need for evaluating the stability of the entire EMU system. Originality/value-Unlike previous studies, we utilize the cross-country distance in the deficit-to-GDP ratio as a measure of fiscal fundamentals distance for the countries under investigation. To the best of our knowledge, our study is the first to analyse this matter in EMU core countries using a GVAR methodology.