Policy uncertainty and the sovereign-bank nexus: A time-frequency analysis using wavelet transformation

This paper examines the impact of policy uncertainty on the sovereign-bank nexus over various time-scales and frequencies. Considering Credit Default Swap premia from 32 banks in 10 countries, cross-wavelet analysis shows that sovereign default risk leads banking sector default risk in the short-run, while the relation reverses in the medium-run. Periods of high sovereign bank dependence, moreover, coincide with periods of great political uncertainty. Applying partial wavelet coherency analysis, the sovereign-bank dependencies significantly weaken once the influence of Economic Policy Uncertainty is eliminated. This shows a tightening of the sovereign bank nexus in times of great policy uncertainty.