Estimating the probability of multiple EU sovereign defaults using CDS and bond data (original) (raw)
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2011
In this paper we take an innovative econometric look at the Euro Zone Sovereign Debt Crisis. We are particularly interested in understanding which determinants have led investors to ask for higher yields on sovereign debt from the Euro shatter belt. We dismiss the definition of speculation previously used in the literature, on the basis of the irrelevance of Granger Causality as an operational tool for this purpose. Instead, we suggest that speculative behavior would only exist if market assessment would be unrelated to economic fundamentals of such countries. Using a cross section of countries, we improve on the scarce literature on the Econometrics of Credit Default Swap Markets on sovereign debt. Firstly, we use an ordered probit model to determine whether economic fundamentals are driving the implied rating assessments. Secondly, we provide a pioneering application of quantile regression to this domain, to determine which variables matter at different conditional quantiles of th...
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SSRN Electronic Journal, 2000
This paper addresses the following questions. Is there evidence of nancial contagion in the Eurozone? To what extent a country's vulnerability to contagion depends on fundamentals as opposed the government's credibility? We look at the empirical evidence on European sovereigns CDS spreads and estimate an econometric model where a crucial role is played by time varying parameters. We model CDS spread changes at country level as reecting three dierent factors: a Global sovereign risk factor, a European sovereign risk factor and a Financial intermediaries risk factor. Our main ndings are as follows. First, Unlike the US subprime crisis which aected all European sovereign risks, the Greek crisis is largely a matter concerning the Euro Zone. Second, dierences in vulnerability to contagion within the Eurozone are even more remarkable: the core Eurozone members become less vulnerable to EUZ contagion, possibly due to a safe-heaven eect, while peripheric countries become more vulnerable. Finally, market fundamentals go a long way in explaining these dierences: they jointly explain between 54 and 80% of the crosscountry variation in idiosyncratic risks and in the vulnerability to contagion, largely supporting the wake-up call hypothesis according to which market participants become more wary of market fundamentals during nancial crises.
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Social Science Research Network, 2011
In this article, we try to realize the best compromise between in-sample goodness of fit and out-of-sample predictability of sovereign defaults. To do this, we use a new regressiontree based approach that signals impending sovereign debt crises whenever pre-selected indicators exceed specific thresholds. Using data from emerging markets and Greece, Ireland, Portugal and Spain (GIPS) over the period 1975-2010, we show that our model significantly outperforms existing competing approaches (logit, stepwise logit, noiseto-signal ratio and regression trees), while balancing in-and out-of-sample performance. Our results indicate that illiquidity (high short-term debt to reserves) and default history, together with real GDP growth and US interest rates, are the main determinants of both emerging market country defaults and the recent European sovereign debt crisis.
Sovereign default Risk in the Euro-Periphery and the Euro-Candidate Countries
Available at SSRN 2145780, 2012
This study examines the key drivers of sovereign default risk in five euro area periphery countries and three euro-candidates that are currently pursuing independent monetary policies. We argue that the recent proliferation of sovereign risk premiums stems from both domestic and international sources. We focus on contagion effects of external financial crisis on sovereign risk premiums in these countries, arguing that the countries with weak fundamentals and fragile financial institutions are particularly vulnerable to such effects. The domestic fiscal vulnerabilities include: economic recession, less efficient government spending and a rising public debt. External ‘push’ factors entail increasing liquidity- and counter-party risks in international banking, as well as risk-hedging appetites of international investors embedded in local currency depreciation against the US Dollar. We develop a model capturing the internal and external determinants of sovereign risk premiums and test for the examined country groups. The results lead us to caution against premature fiscal consolidation in the aftermath of the global economic crisis, since such policy might actually worsen sovereign default risk. The model works well for the euro-periphery countries; it is less robust for the euro-candidates that upon a future euro adoption will have to pursue real economy growth oriented policies in order to mitigate a potential increase in sovereign default risk.
International Journal of Accounting and Financial Reporting, 2018
The Greek crisis has brought to light the strong nexus between the credit risks of European banks and their sovereign. We study this phenomenon in Germany, France, Italy and Spain by estimating the conditional correlations between sovereign and bank CDS bond spreads over the period 2006-2015. Trivariate time-varying regime switching correlation analyses, such as the STCC-GARCH and DSTCC-GARCH, are implemented to associate causally the state shifts to the dynamics of the so-called “transition variables”. We find evidence of significant changes in the correlation structures due to the evolution of both the Greek and Italian crises.
Global Macro-Financial Shocks and expected default frequencies in the Euro area
2008
Modelling the link between the global macro-financial factors and firms’ default probabilities constitutes an elementary part of financial sector stress-testing frameworks. Using the Global Vector Autoregressive (GVAR) model and constructing a linking satellite equation for the firm-level Expected Default Frequencies (EDFs), we show how to analyse the euro area corporate sector probability of default under a wide range of domestic and foreign macroeconomic shocks. The results show that, at the euro area aggregate level, the median EDFs react most to shocks to the GDP, exchange rate, oil prices and equity prices. There are some intuitive variations to these results when sector-level EDFs are considered. Overall, the Satellite-GVAR model appears to be a useful tool for analysing plausible global macrofinancial shock scenarios designed for financial sector stress-testing purposes. JEL Classification: C33, F47, G32, G33.
Estimating the joint probability of default using CDS and bond data
2011
Systemic default risk -i.e. the risk of simultaneous default of multiple institutions- has caused great concern in the recent past. The aim of this paper is to estimate the joint probability of default for couples of financial institutions. Both bond and credit derivative markets convey information on the default process: the former provides information on the marginal whilst the latter on the joint default probabilities. In this paper we will consider the corporate bond and the credit default swap (CDS) markets. The OTC nature of the CDS market implies the presence of counterparty risk, i.e. the risk that the protection seller will fail to fulfill its obligations. The counterparty risk is reflected in the CDS price through the joint default probability of the reference entity and the protection seller. Applying a no-arbitrage argument, we extract from market data forwardlooking joint default probabilities of financial institutions operating in the CDS market during the period 03-Ja...
CoRisk: Measuring Systemic Risk Through Default Probability Contagion
SSRN Electronic Journal, 2016
We propose a novel systemic risk measurement model, based on stochastic processes, correlation networks and conditional probabilities of default. For each country we consider three different spread measures, one for each sector of the economy (sovereigns, corporates, banks), and we model each of them as a linear combination of two stochastic processes: a country-specific idiosyncratic component and a common systematic factor. We then build a partial correlation network model, and by combining it with the spread measures we derive the conditional default probabilities of each sector. Comparing them with the unconditional ones, we obtain the CoRisk, which measures the variation in the probability of default due to contagion effects. Our measurement model is applied to understand the time evolution of systemic risk in the economies of the European monetary union, in the recent period. The results show that, overall, the sovereign crisis has increased systemic risks more than the financial crisis. In addition, peripheral countries turn out to be exporters, rather than importers of systemic risk, and, conversely, core countries.
Journal of Financial Management, Markets and Institutions (ISSN 2282-717X) Fascicolo 1, gennio-giugno 2013 Copyright c by Società editrice il Mulino, Bologna. Tutti i diritti sono riservati. Per altre informazioni si veda https://www.rivisteweb.it Licenza d'uso L'articolò e messo a disposizione dell'utente in licenza per uso esclusivamente privato e personale, senza scopo di lucro e senza fini direttamente o indirettamente commerciali. Salvo quanto espressamente previsto dalla licenza d'uso Rivisteweb, ` e fatto divieto di riprodurre, trasmettere, distribuire o altrimenti utilizzare l'articolo, per qualsiasi scopo o fine. Tutti i diritti sono riservati. Abstract This work estimates a reduced model of the determinants of the 10-year yield spreads relative to Germany for 10 Eurozone countries. Results show that since the inception of the 2007 crisis, spreads have exhibited a rising time-dependent component. Country specific estimated responses to financial turmoil ...