Credit Risk Connectivity in the Financial Industry and Stabilization Effects of Government Bailouts

We identify the connections between financial institutions from different sectors of the financial industry based on joint extreme movements in credit default swap (CDS) spreads. First, we estimate pairwise co-crash probabilities (CCP) to identify significant connections among 193 international financial institutions and explain CCPs with shared country and/or sectoral origin indicators. Second, we use network centrality measures to identify systemically important financial institutions. Third, we test if bailouts stabilized network neighbors and thus this financial system. Financial firms from the same sector and country are most likely significantly connected. Inter-sector and intra-sector connectivity across countries also increase the likelihood of significant links. Central network indicators based on significant CCPs identify many institu- tions that failed during the 2007/2008 crisis. Excess equity returns in response to bank bailouts are overall negative and significantly lower for connected banks