Financial contagion is a major risk in the European Monetary Union (EMU) due to the interdependence of government and the banking system. As highlighted by the literature, a doom-loop cycle between governments and banks may well exist. This work empirically investigates the sovereign-bank risk transmission across eight EMU countries from 2012 to 2018 to ascertain to what extent an increase in risk of Italian government bonds can affect the sovereign and banking risk of non-stressed countries. We employ a global VAR (GVAR) technique and measure spatial proximity with the cross-country "distance" in the debt-to-GDP ratio. We find that an increase in Italian risk causes a heterogeneous increase in the sovereign and financial risk of other countries. The results confirm the hypothesis of a cross-border doom-loop and show that contagion depends on market integration among countries. Spillover effects indirectly amplify the shock spread through financial linkages and similarities in fiscal fundamentals.
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