Within and between systemic country risk. Theory and evidence from the sovereign crisis in Europe

We propose a hierarchical Marshall–Olkin model of countrywide systemic risk. At the lower level, we model the systemic risk of a crisis within the banking system (that we call ‘‘within’’ systemic risk) and at the higher level we model the probability of a joint default of the banking system and the public sector (that we call ‘‘between’’ systemic risk). We apply the model to four countries of Northern Europe and four of Southern Europe. In Northern Europe, Germany ranks third for soundness of the banking system but first for country safety. The opposite findings are obtained for Netherlands. In Southern Europe, the Italian banking system ranks first for soundness, quite above Spain, while Italy is aligned with Spain for countrywide risk. Differences in default time correlations between the banking and the public sectors explain these findings.