Sovereign and bank CDS spreads: two sides of the same coin?

This paper investigates the relationship between sovereign and bank CDS
spreads with reference to their ability to convey timely signals on the
default risk of European sovereign countries and their banking systems.
By using a sample including six major European economies, we find that
sovereign and bank CDS spreads are cointegrated variables at the country
level. We then perform a more in-depth investigation of the underlying
price discovery mechanisms, and find that both variables have an
important price discovery role in the period preceding the financial
crisis of 2007-2009. However, during the global financial crisis and the
subsequent European sovereign debt crisis, sovereign CDS spreads
dominate the price discovery process. Our findings suggest that,
especially during crisis periods, sovereign CDS spreads incorporate more
timely information on the default probability of European banks than
their corresponding bank CDS spreads.