BRRD credibility and the bank-sovereign nexus

We investigate the effectiveness of the Bank Recovery and Resolution Directive (BRRD) in mitigating the bank-sovereign nexus in the Euro Area. Using CDS spreads to measure bank and sovereign credit risk and a DCC-MIDAS model capturing the long-term component of bank-sovereign interconnectedness, we document that the dynamic correlation between banks and sovereigns has decreased in Euro Area countries since the introduction of the BRRD. Panel data analysis reveals that the decline in interconnectedness is not driven by the banks' capital adequacy, size or holdings of domestic sovereign securities.