Sovereign Contagion in Europe: Evidence from the CDS Market (original) (raw)
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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 ...
Sovereign Risk Premia in the Euro Area and the Role of Contagion
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 highlight three major results. Core countries have not been affected by financial contagion during the subprime crisis, and from 2011 onwards, they have benefited from government yield spreads that are lower than what is explainable by the underlying fundamentals. Peripheral member countries (except Italy) – which from the outset of the EMU benefited from underpricing of their economic and fiscal fragility due to the implicit bailout insurance – have suffered from a revision of market expectations since 2010. Italy, penalised by its historically high debt-to-GDP ratio, has been hit by a rising contagion effect since 2010, which is estimated to account for 180 b.p. of the spread observable in the 1st semester of 2012.
Measuring Sovereign Contagion in Europe
SSRN Electronic Journal, 2000
This paper analyzes the sovereign risk contagion using CDS and bond spread for the major euro area countries. Using several econometric approaches (non linear regression, quantile regression and Bayesian quantile regression with heteroskedasticity) we show that propagation of shocks in Europe's CDS's has been remarkably constant for the period 2008-2011 even though in a significant part of the sample periphery countries have been extremely affected by their sovereign debt and fiscal situations. Thus, the integration among the different countries is stable, and the risk spillover among countries is not affected by the size of the shock. Results for the same sample are confirmed by bond spreads. However, the analysis on bond data shows that there is a change in the intensity of the propagation of shocks in the pre crisis period (2003)(2004)(2005)(2006) and the post Lehman one (2008)(2009)(2010)(2011) and the coefficients actually come down, not up! All the increases in correlation we have witnessed in the last two years is coming from larger shocks and the heteroskedasticity in the data, and not from similar shocks propagated with higher intensity across Europe. This is the first paper, to our knowledge, where a Bayesian quantile regression approach is used to measure contagion. This methodology is particularly good to deal with non-linear and unstable transmission mechanisms.
2020
This paper examines the evolution of the dynamic relationship between the sovereign credit default swap (CDS) market and the sovereign bond market (ranked by maturity) during the period 2010 to 2016 to detect the direct and indirect contingent power of these products. For this purpose, our research paper proposes an ADCC-garch model. The results show that the maturity significantly affects the sensitivity of sovereign bonds to contagion. Also, while sovereign CDS present a channel of fundamental contagion, particular channels should be considered, especially for sovereign bonds with short-maturity that are very exposed to these channels.
2017
We develop a theory of sovereign risk contagion based on financial links. In our multi-country model, sovereign bond spreads comove because default in one country can trigger default in other countries. Countries are linked because they borrow, default, and renegotiate with common lenders, and the bond price and recovery schedules for each country depend on the choices of other countries. A foreign default increases the lenders' pricing kernel, which makes home borrowing more expensive and can induce a home default. Countries also default together because by doing so they can renegotiate the debt simultaneously and pay lower recoveries. We apply our model to the 2012 debt crises of Italy and Spain and show that it can replicate the time path of spreads during the crises. In a counterfactual exercise, we find that the debt crisis in Spain (Italy) can account for one-half (one-third) of the increase in the bond spreads of Italy (Spain).
Causes and hazards of the euro area sovereign debt crisis: Pure and fundamentals-based contagion
Economic Modelling, 2016
This paper tries to contribute to the understanding of sovereign debt crises' pattern by empirically investigating the determinants of the recent euro area crisis to assess if its transmission was due to "pure" or "fundamentals-based" contagion. Using sovereign bond yield spreads with respect to Germany for a sample of ten central and peripheral countries from January 1999 to December 2012, we firstly examine the dynamic evolution of Granger-causality within the 90 pairs of yield spreads in our sample to detect episodes of contagion (associated with episodes of significant intensification in causality). Secondly, we make use of a logit model to explore whether there is evidence of "pure contagion" or "fundamentals-based contagion", by trying to determine which factors might have been behind the detected contagion episodes. Our results suggest that contagion episodes are concentrated just after the inception of the EMU and matching the Global Financial Crisis, yielding more accurate and sensible indicators than those obtained from DCC-GARCH models used in prior studies. Indeed, they preceded the outburst of the Global Financial Crisis (causality intensification is detected from March 2008), and reached a peak during January-May 2011. Furthermore, they underline the coexistence of "pure" and "fundamentals-based contagion" during the recent European 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.
Impacts of the financial crisis on eurozone sovereign CDS spreads
Journal of International Money and Finance, 2014
We study the variation of sovereign credit default swaps (CDSs) of eurozone countries, their persistence and co-movements, with particular attention given to the impact of the financial crisis. Specifically, using a dual fractional integration model, we test the evidence of long memory for CDSs of ten eurozone countries. Our analysis reveals that price discovery processes satisfy the minimum requirements for a weak form of efficiency for sovereign CDS markets, even during the crisis. In contrast, we document the spreading out of persistent CDS uncertainty among the peripheral economies with its outbreak. We provide evidence that CDS uncertainty has implications for the pricing of sovereign risk including that of core countries in the crisis period. Finally, we present the potential spillover effects utilizing a dynamic q The authors wish to thank to the managing guest editor
Measuring Contagious Effects on Euro Area Debt Crisis Using Daily CDS Spreads Changes
This paper complements several recent studies on the contagion in the euro area after the historic tensions on the debt market. We consider the popular approach of dynamic conditional correlation (DCC) as introduced by Engle (2002) for sovereign CDS spreads associated with selected euro area countries. Additionally, we extend prior results by explaining to what extent the contagion is generated by market and macroeconomic indicators.
EMU Sovereign Debt Market Crisis: Fundamentals-Based or Pure Contagion?
SSRN Electronic Journal, 2014
We empirically investigate whether the transmission of the recent crisis in euro area sovereign debt markets was due to fundamentals-based or pure contagion. To do so, we examine the behaviour of EMU sovereign bond yield spreads with respect to the German bund for a sample of both central and peripheral countries from January 1999 to December 2012. First we apply a dynamic approach to analyse the evolution of the degree of Grangercausality within the 90 pairs of sovereign bond yield spreads in our sample, in order to detect episodes of significantly increased causality between them (which we associate with contagion) and episodes of significantly reduced interconnection (which we associate with immunisation). We then use an ordered logit model to assess the determinants of the occurrence of the episodes detected. Our results suggest the importance of variables proxying market sentiment and of variables proxying macrofundamentals in determining contagion and immunisation outcomes. Therefore, our findings underline the coexistence of "pure" and "fundamentals-based contagion" during the recent European debt crisis.