Unveiling the connectedness between China’s local government debt risk and financial fragility

Local government debt risk, financial institution risk, and real estate risk are three major concerns for China's economic stability. This study employs an integrated quantile-time–frequency approach to analyse systemic spillovers between China's local government debt risk and financial fragility, providing a multidimensional analysis of spillover variations across risk quantiles, temporal evolution, and frequency domains. The financial fragility is calculated by incorporating financial market information of a total of 130 listed financial institutions and real estate developers within the relative tail dependence framework. The study finds that: (1) China’s financial fragility is fundamentally shaped by institutionalized spillover networks where local government debt transmits and amplifies systemic instability. Notably, the real estate sector serves as a critical nexus, as the land finance model binds municipal debt risks to property market dynamics, creating structural interdependencies that propagate risks through collateral devaluation and fiscal contraction. (2) Risk connectedness varies across frequencies. Specifically, short-term spillovers dominate crisis periods, potentially driven by liquidity mismatches and herding behaviour, while medium- and long-term spillovers reflect structural vulnerabilities rooted in fiscal-institutional symbiosis. (3) Asymmetric risk amplification mechanisms exist, with tail-quantile spillovers much higher than median-quantile. Under extreme market conditions, the banking and securities sectors persistently dominate systemic risk propagation, while local government debt and real estate sectors remain structurally vulnerable as net risk absorbers, with the insurance sector transitioning from risk mitigation to amplification at stress extremes. Our findings advance understanding of financial stability mechanisms while informing regulatory strategies for emerging economies facing similar systemic risk challenges.