Dynamic Connectedness between Credit and Liquidity Risks in EMU Sovereign Debt Markets

We examine the dynamic interconnection between sovereign credit and liquidity risks in ten euro area countries at the five year maturity with high-frequency data from MTS between January 2008 and December 2018 using the extension of the TVP-VAR connectedness approach of Antonakakis et al. (2020). Our results indicate that for most periods net connectedness is from credit risk to liquidity risk. This indicator is time-dependent, detecting some episodes where it goes from liquidity risk to credit risk. Through an event study we find that the latter episodes can be related to several ECB unconventional monetary policy measures. Through a Probit model, we examine the drivers of the connectedness indicator. Our results suggest that monetary policy shocks and economic policy uncertainty increase the probability of transmission from liquidity risk to credit risk, while global funding liquidity, tensions in financial markets and surprises in inflation and GDP reduce such probability