The Impact of Sovereign Shocks

This paper studies the dynamic propagation mechanisms of systemic risk shocks within and across macrosystems of governments and financial institutions. We propose a novel approach to identify relevant systemic shocks and to classify them into sovereign or banking categories. We find that sovereign shocks have a significant and persistent impact on the probability of a collective banking default. We also explore channels through which these shocks propagate and identify how sovereign fiscal fragility and banking exposure are relevant mechanisms of shock transmission.