The Relation between Sovereign Credit Default Swap Premium and Banking Sector Risk in Poland

We investigate causality between returns on sovereign CDSs and bank equities for Poland between 2004 and 2014 to provide evidence on contagion between sovereign and banking sector risk pricing. We find some evidence of contagion from Polish sovereign CDS returns to bank equity returns during the crisis period. We benchmark the results for Poland against a sample ofWestern European countries. We document strong negative correlation between sovereign CDS and bank equity returns for individual countries as well as strong commonality of both sovereign and banking sector risks across different countries. We do not however find a clear pattern of contagion between these two markets across European countries. To further investigate drivers of CDS and bank equity returns, we conduct principal component analysis and we find that first three principal components explain as much as 97% of variation with the third principal component mostly associated with Polandspecific risk.