Essays on Sovereign Risk and Banking
This thesis consists of three essays on sovereign risk and banking.

In the first essay, we examine the determinants of sovereign risk in the Eurozone focusing on the recent crisis episode and search for a self-fulfilling contagion link by using an exogenous ECB policy announcement for identification. our principal components analysis reveals that the perceived commonality in default risk among peripheral and core Eurozone countries increased after the announcement. An event study detects significant pre-announcement news transmission from Spain to Italy, Belgium, France and Austria that clearly dissipates post-announcement. Country-specific regressions of CDS spreads on systematic risk factors illustrate frequent days of large adverse shocks affecting simultaneously those same Eurozone countries during the pre-announcement period; but not afterwards. Altogether these findings support the view that market expectations during Eurozone crisis were at least partially self-fulfilling and ECB policy helped to contain such adverse dynamics. 

In the second essay we focus on European banks' sovereign bond exposures. By using a novel bank-level dataset covering the entire timeline of the Eurozone crisis, we first reconfirm that the crisi led to the reallocation of sovereign debt from foreign to domestic banks. This reallocation was only visible for banks as opposed to other domestic private agents and it cannot be explained by the banks' risk-shifting tendency. In contrast to the recent literature focusing only on sovereign debt. We show that the bank's private sector exposures were (at least) equally affected by a rise in home bias. Finally, we propose a new debt reallocation channel based on informational frictions and show that crisi-country debt was not only reallocated to domestic banks, but also to the informationally closer foreign banks. Our results imply that informational asymmetries among banks played a key role in the recent fragmentation across Eurozone debt markets. 

In the third essay, our investigation shifts towards political economy aspects of the relationship between sovereigns and domestic banks. We use date on the universe of credit extended over a 14 year period in Turkey to document a strong political lending cycle. We find that state-owned banks systemically adjust their provincial lending around local elections relative to the private banks in the same province. there is considerable tactical redistribution: state-pwned banks increase loans in politically competitive provinces with a current mayor aligned with the ruling party but reduce it in similar provinces with a current mayor from opposition.this effect only exists in corporate lending as opposed to consumer loans, suggesting that tactical redistribution targets job creation to increase electoral success. Such political lending also seems to influence real outcomes as the credit constrained opposition areas suffer a drop in economic output as measured by local construction activity.