A New Measure for Gauging the Riskiness of European Banks’ Sovereign Bond Portfolios

For a sample of 51 European banks, during 2010-2016, we construct a novel measure (SovRisk) which captures the riskiness of sovereign bond portfolios. We demonstrate the ability of this measure to explain the phases of the European sovereign debt crisis, while accounting for the substantial differences among distressed and non-distressed countries. We contend that SovRisk can be used as complement to bank Credit Default Swap (CDS) spreads, or a substitute in the absence of traded CDS, for measuring banks’ sovereign risk.