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. Specifically, Economic Policy Uncertainty leads sovereign and bank default risk for a horizon of up to 1 year. This constitutes a tightening of the Sovereign-Bank Nexus in times of uncertain election outcomes and great Economic Policy Uncertainty