the margin; in particular, since the stress tests revealed new information about bank holding, but little news about the underlying quality of those securities.

|**Impact of banks’ exposure togovern**|**ment debt**<br>|**on stock**<br>|**and CDS**<br>|**marketpe**<br>|**rformance**<br>|
|---|---|---|---|---|---|
||(1)|(2)|(3)|(4)|(5)|
|*|Banks'|stock market|returns|***<br>Banks' CD|***<br>S spreads|
|Sovereign CDSDomestic sovereign exposure|-1.664***|-1.782***|-1.690***|0.159|0.115|
||(0.396)|(0.425)|(0.401)|(0.062)|(0.047)|
|Domestic sovereign exposure (% assets)|-0.009||0.003|0.443*|0.596***|
||(0.038)||(0.040)|(0.266)|(0.183)|
|Sovereign CDS|-0.177***|-0.182***|-0.186***|0.041***||
||(0.035)|(0.037)|(0.035)|(0.005)||
|Bank FE|Yes||Yes|Yes|Yes|
|Country FE|Yes|Yes||Yes||
|Year||||Yes||
|Year-month FE|Yes|||||
|Bank-year-month FE||Yes||||
|Country-year-month FE|||Yes||Yes|
|Number of countries|12|12|12|5|5|
|Number of banks|33|33|33|29|29|
|Observations|1,468|1,468|1,468|1,849|1,849|
|R-squared|0.234|0.305|0.273|0.60|0.66|

Notes: In columns 1-3 the dependent variable is the bank’s stock market return and the sample contains 33 domestic banks from 12 euro area countries. The data are pooled over EBA stress test release periods, where each period includes the day of data release and the subsequent 10 trading days, during Mar 2010-Dec 2013. Regressions are run at the bank-trading day level. “Domestic exposure” is the ratio of the bank’s total holdings of domestic sovereign bonds to the bank’s total assets. “Sovereign CDS” is the log-difference of daily CDS spreads on a 5-year government bond. In columns 4-5 the dependent variable is the bank’s CDS spread and the sample includes 29 domestic banks in Greece, Ireland, Italy, Portugal, and Spain. Regressions are run at the bank-month level. The time period is Aug 2007-Jun 2013. “Sovereign CDS” is the maximum CDS spread on a 10-year sovereign bond during the month. “Domestic exposure” is the ratio of the bank’s total holdings of domestic sovereign bonds to the bank’s total assets (divided by 1000). A constant term is included (coefficient not shown). Standard errors clustered at the bank level appear in parentheses, where *** indicates significance at the 1% level, ** at the 5% level, and * at the 10% level. Sources: ECB Individual MFI Balance Sheet Statistics, European Banking Authority, Bankscope, Bloomberg, SNL Financial, and Datastream.

# 9 Discussion and conclusions

This paper reexamines the theoretical relationship between the expectation of a government bailout of bank debtholders (depositors and bondholders) and bank risk taking. After the Global Financial Crises, the regulatory policy debate has centered on how to make ...nancial institutions safer and more resilient to shocks. Within that debate, the classical argument that explicit (typically deposit insurance) or implicit (typically the expectation of a public bailout of bondholders) government guarantees on bank liabilities entail a moral hazard e¤ect that increases bank risk taking has played a prominent role. Yet, this argument critically relies on debtholders and depositors’ability to price bank risk at the margin. Put di¤erently, it requires the cost of bank liabilities to re‡ect changes in bank behavior. In contrast, absent this ability, the presence of government guarantees improves bank incentives by reducing the cost of their liabilities and hence increasing their charter value.

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