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 5-year maturity with high-frequency data from MTS over the period January 2008-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, but this indicator is time-dependent, detecting some episodes where it goes from liquidity risk to credit risk. We set up an event study and find that the latter episodes can be related to several unconventional monetary policy measures of the ECB. Then, we examine the drivers of the connectedness indicator by means of a Probit model. Our results suggest that monetary policy shocks and economic policy uncertainty increase the probability of risk transmission from liquidity to credit, while global funding liquidity, tensions in financial markets and surprises in inflation and GDP are factors that reduce such probability