Analyzing Credit Risk Transmission to the Non- Financial Sector in Europe: A Network Approach

We use a factor model and elastic net shrinkage to model a high-dimensional network of
European CDS spreads. Our empirical approach allows us to assess the joint
transmission of bank and sovereign risk to the non-financial corporate sector. Our
findings identify a sectoral clustering in the CDS network, where financial institutions are
in the center and non-financial entities as well as sovereigns are grouped around the
financial center. The network has a geographical component reflected in different
patterns of real-sector risk transmission across countries. Our framework also provides
dynamic estimates of risk transmission, a useful tool for systemic risk monitoring.