Analysis of Dynamic Connectedness among Sovereign CDS Premia
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Abstract
This paper studies the dynamics of spillovers between sovereign Credit Default Swap (CDS) premia of nine countries, including Turkey, Russia, Brazil, South Africa, China, Germany, France, Italy and Spain. Weekly CDS data spans from July 2012 through June 2022. Adopting the methodology developed by Diebold & Yılmaz (2014), several connectedness measures are computed based on generalized forecast error variance decompositions generated through a time-varying parameter vector autoregressive model (TVP-VAR). The results show that the network’s connectedness level increased significantly during the COVID-19 outbreak and the Ukrainian war. Higher connectedness levels among European markets and developing countries are observed. Especially the connectedness levels between South Africa and other developing countries are remarkably high. The results reveal both fundamental-based and pure contagion channels and provide insight into the dynamic network of risk spillovers. A thorough understanding of international risk transmission channels is crucial for policy-makers and global investors regarding risk mitigation.
JEL classification: F36, G15, H63
Keywords: Connectedness, Sovereign CDS premia, Spillovers, TVP-VAR analysis
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Ceylan, Özcan (2023) “Analysis of Dynamic Connectedness among Sovereign CDS Premia”, World Journal of Applied Economics, 9(1), pp. 33-47. doi: 10.22440/wjae.9.1.2.
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References
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Ang, A., & Longstaff, F. A. (2013). Systemic sovereign credit risk: Lessons from the U.S. and Europe. Journal of Monetary Economics, 60, 493-510. doi:10.1016/j.jmoneco.2013.04.009
Antonakakis, N., Chatziantoniou, I., & Gabauer, D. (2020). Refined measures of dynamic connectedness based on time-varying parameter vector autoregressions. Journal of Risk and Financial Management, 13, 84. doi:10.3390/jrfm13040084
Augustin, P., Sokolovski, V., Subrahmanyam, M. G., & Tomio, D. (2022). In sickness and in debt: The covid-19 impact on sovereign credit risk. Journal of Financial Economics, 143, 1251-1274. doi:10.1016/j.jfineco.2021.05.009
Baig, T., & Goldfajn, I. (1999). Financial market contagion in the Asian crisis. IMF Staff Papers, 46, 167-195. doi:10.2307/3867666
Barberis, N., & Shleifer, A. (2003). Style investing. Journal of Financial Economics, 68, 161-199. doi:10.1016/S0304-405X(03)00064-3
Barberis, N., Shleifer, A., & Wurgler, J. (2005). Comovement. Journal of Financial Economics, 75, 283-317. doi:10.1016/j.jfineco.2004.04.003
Bekaert, G., Harvey, C. R., & Ng, A. (2005). Market integration and contagion. Journal of Business, 78, 39-69. doi:10.1086/426519
Berg, A., & Patillo, C. (1999). Are currency crises predictable? A test. IMF Staff Papers, 46, 107-138. doi:10.2307/3867664
Bostanci, G., & Yilmaz, K. (2020). How connected is the global sovereign credit risk network? Journal of Banking and Finance, 113, 105761. doi:10.1016/j.jbankfin.2020.105761
Bouoiyour, J., & Selmi, R. (2019). Brexit and CDS spillovers across UK and Europe. European Journal of Comparative Economics, 16, 105-124. doi:10.25428/1824-2979/201901-105-124
Bouri, E., Shahzad, S. J., Raza, N., & Roubaud, D. (2018). Oil volatility and sovereign risk of BRICS. Energy Economics, 70, 258-269. doi:10.1016/j.eneco.2017.12.018
Brunnermeier, M. K., Garicano, L., Lane P., R., Pagano, M., Reis, R., Santos, T., . . . Vayanos, D. (2016). The sovereign-bank diabolic loop and ESBies. American Economic Review, 106, 508-512. doi:10.1257/aer.p20161107
Calvo, S., & Reinhart, C. M. (1996). Capital flows to Latin America: Is there evidence of contagion effects? In G. G. Calvo (Ed.), Private Capital Flows to Emerging Markets. Institute for International Economics, Washington DC.
De Santis, R. A. (2012). The Euro area sovereign debt crisis: Safe haven, credit rating agencies and the spread of the fever from Greece, Ireland and Portugal. Working Paper, ECB.
Del Negro, M., & Primiceri, G. E. (2015). Time varying structural vector autoregressions and monetary policy: A corrigendum. Review of Economic Studies, 82, 1342-1345. doi:10.1093/restud/rdv024
Diebold, F. X., & Yilmaz, K. (2009). Measuring financial asset return and volatility spillovers, with application to global equity markets. Economic Journal, 119, 158-171. doi:10.1111/j.1468-0297.2008.02208.x
Diebold, F. X., & Yilmaz, K. (2012). Better to give than to receive: Predictive directional measurement of volatility spillovers. International Journal of Forecasting, 28, 57-66. doi:10.1016/j.ijforecast.2011.02.006
Diebold, F. X., & Yilmaz, K. (2014). On the network topology of variance decompositions: Measuring the connectedness of financial firms. Journal of Econometrics, 182, 119-134. doi:10.1016/j.jeconom.2014.04.012
Doshi, H., Jacobs, K., & Zurita, V. (2017). Economic and financial determinants of credit risk premiums in the sovereign CDS market. Review of Asset Pricing Studies, 7, 43-80. doi:10.1093/rapstu/rax009
Dungey, M., Fry, R., Gonzalez-Hermosillo, B., & Martin, V. L. (2005). Empirical modelling of contagion: A review of methodologies. Quantitative Finance, 5, 9-24. doi:10.1080/14697680500142045
Eichengreen, B., Rose, A. K., & Wyplosz, C. (1996). Contagious Currency Crises: First Tests. Scandinavian Journal of Economics, 98, 463-484. doi:10.2307/3440879
Feng, Q., Sun, X., Liu, C., & Li, J. (2021). Spillovers between sovereign CDS and exchange rate markets: The role of market fear. North American Journal of Economics and Finance, 55, 1-42. doi:10.1016/j.najef.2020.101308
Forbes, K. J., & Rigobon, R. (2002). No contagion, only interdependence: measuring stock market comovements. Journal of Finance, 17, 2223-2261. doi:10.1111/0022-1082.00494
Gai, P., & Kapadia, S. (2010). Contagion in financial networks. Working Paper, Bank of England.
Guo, Y., Li, P., & Li, A. (2021). Tail risk contagion between international financial markets during COVID-19 pandemic. International Review of Financial Analysis, 73, 101649. doi:10.1016/j.irfa.2020.101649
Hui, C.-H., & Fong, T. P.-W. (2015). Price cointegration between sovereign CDS and currency option markets in the financial crises of 2007-2013. International Review of Economics and Finance, 40, 174-190. doi:10.1016/j.iref.2015.02.011
Jeanneret, A. (2018). Sovereign credit spreads under good/bad governance. Journal of Banking and Finance, 93, 230-246. doi:10.1016/j.jbankfin.2018.04.005
Karolyi, G. A., & McLaren, K. J. (2017). Racing to the exits: International transmission of funding shocks during the Federal Reserve’s taper experiment. Emerging Market Review, 32, 96-115. doi:10.1016/j.ememar.2017.05.009
Khallouli, W., & Sandretto, R. (2012). Testing for ``contagion'' of the subprime crisis on the Middle East and North African stock markets: A Markov switching EGARCH approach. Journal of Economic Integration, 27, 134-166. doi:10.11130/jei.2012.27.1.134
King, M., & Wadhwani, S. (1990). Transmission of volatility between stock markets. Review of Financial Studies, 3, 5-33. doi:10.1093/rfs/3.1.5
Koop, G., & Korobilis, D. (2014). A new index of financial conditions. European Economic Review, 71, 101-116. doi:10.1016/j.euroecorev.2014.07.002
Koop, G., Pesaran, M. H., & Potter, S. M. (1996). Impulse response analysis in nonlinear multivariate models. Journal of Econometrics, 74, 119-147. doi:10.1016/0304-4076(95)01753-4
Le, C., Dickinson, D., & Le, A. (2022). Sovereign risk spillovers: A network approach. Journal of Financial Stability, 60, 101006. doi:10.1016/j.jfs.2022.101006
Lin, W. L., Engle, R., & Ito, T. (1994). Do bulls and bears move across borders? International transmission of stock returns and volatility. Review of Financial Studies, 7, 507–538. doi:10.1093/rfs/7.3.507
Longstaff, F. A., Pan, J., Pedersen, L. H., & Singleton, K. J. (2011). How sovereign is sovereign credit risk? American Economic Journal: Macroeconomics, 3, 75-103. doi:10.3386/w13658
Masson, P. (1998). Contagion: Monsoonal Effects, Spillovers, and Jumps between Multiple Equilibria. Working Paper, IMF.
Naifar, N., & Shahzad, S. J. (2022). Tail event-based sovereign credit risk transmission network during COVID-19 pandemic. Finance Research Letters, 45, 102182. doi:10.1016/j.frl.2021.102182
Pesaran, M. H., & Shin, Y. (1998). Generalized impulse response analysis in linear multivariate models. Economics Letters, 58, 17-29. doi:10.1016/S0165-1765(97)00214-0
Primiceri, G. E. (2005). Time varying structural vector autoregressions and monetary policy. Review of Economic Studies, 72, 821-852. doi:10.1111/j.1467-937X.2005.00353.x
Sabkha, S., de Peretti, C., & Hmaied, D. M. (2019). International risk spillover in sovereign credit markets: An empirical analysis. Managerial Finance, 45, 1020-1040. doi:10.1108/MF-11-2017-0490
Srivastava, S., Lin, H., Premachandra, I. M., & Roberts, H. (2016). Global risk spillover and the predictability of sovereign CDS spread: International evidence. International Review of Economics and Finance, 41, 371-390. doi:10.1016/j.iref.2015.10.047
Aizenman, J., Hutchison, M., & Jinjarak, Y. (2013). What is the risk of European sovereign debt defaults? Fiscal space, CDS spreads and market pricing of risk. Journal of International Money and Finance, 34, 37-59. doi:10.1016/j.jimonfin.2012.11.011
Allen, F., & Gale, D. (2000). Financial contagion. Journal of Political Economy, 18, 1-33. doi:10.1086/262109
Alter, A., & Beyer, A. (2014). The dynamics of spillover effects during the European sovereign debt turmoil. Journal of Banking and Finance, 42, 134-153. doi:10.1016/j.jbankfin.2014.01.030
Ang, A., & Longstaff, F. A. (2013). Systemic sovereign credit risk: Lessons from the U.S. and Europe. Journal of Monetary Economics, 60, 493-510. doi:10.1016/j.jmoneco.2013.04.009
Antonakakis, N., Chatziantoniou, I., & Gabauer, D. (2020). Refined measures of dynamic connectedness based on time-varying parameter vector autoregressions. Journal of Risk and Financial Management, 13, 84. doi:10.3390/jrfm13040084
Augustin, P., Sokolovski, V., Subrahmanyam, M. G., & Tomio, D. (2022). In sickness and in debt: The covid-19 impact on sovereign credit risk. Journal of Financial Economics, 143, 1251-1274. doi:10.1016/j.jfineco.2021.05.009
Baig, T., & Goldfajn, I. (1999). Financial market contagion in the Asian crisis. IMF Staff Papers, 46, 167-195. doi:10.2307/3867666
Barberis, N., & Shleifer, A. (2003). Style investing. Journal of Financial Economics, 68, 161-199. doi:10.1016/S0304-405X(03)00064-3
Barberis, N., Shleifer, A., & Wurgler, J. (2005). Comovement. Journal of Financial Economics, 75, 283-317. doi:10.1016/j.jfineco.2004.04.003
Bekaert, G., Harvey, C. R., & Ng, A. (2005). Market integration and contagion. Journal of Business, 78, 39-69. doi:10.1086/426519
Berg, A., & Patillo, C. (1999). Are currency crises predictable? A test. IMF Staff Papers, 46, 107-138. doi:10.2307/3867664
Bostanci, G., & Yilmaz, K. (2020). How connected is the global sovereign credit risk network? Journal of Banking and Finance, 113, 105761. doi:10.1016/j.jbankfin.2020.105761
Bouoiyour, J., & Selmi, R. (2019). Brexit and CDS spillovers across UK and Europe. European Journal of Comparative Economics, 16, 105-124. doi:10.25428/1824-2979/201901-105-124
Bouri, E., Shahzad, S. J., Raza, N., & Roubaud, D. (2018). Oil volatility and sovereign risk of BRICS. Energy Economics, 70, 258-269. doi:10.1016/j.eneco.2017.12.018
Brunnermeier, M. K., Garicano, L., Lane P., R., Pagano, M., Reis, R., Santos, T., . . . Vayanos, D. (2016). The sovereign-bank diabolic loop and ESBies. American Economic Review, 106, 508-512. doi:10.1257/aer.p20161107
Calvo, S., & Reinhart, C. M. (1996). Capital flows to Latin America: Is there evidence of contagion effects? In G. G. Calvo (Ed.), Private Capital Flows to Emerging Markets. Institute for International Economics, Washington DC.
De Santis, R. A. (2012). The Euro area sovereign debt crisis: Safe haven, credit rating agencies and the spread of the fever from Greece, Ireland and Portugal. Working Paper, ECB.
Del Negro, M., & Primiceri, G. E. (2015). Time varying structural vector autoregressions and monetary policy: A corrigendum. Review of Economic Studies, 82, 1342-1345. doi:10.1093/restud/rdv024
Diebold, F. X., & Yilmaz, K. (2009). Measuring financial asset return and volatility spillovers, with application to global equity markets. Economic Journal, 119, 158-171. doi:10.1111/j.1468-0297.2008.02208.x
Diebold, F. X., & Yilmaz, K. (2012). Better to give than to receive: Predictive directional measurement of volatility spillovers. International Journal of Forecasting, 28, 57-66. doi:10.1016/j.ijforecast.2011.02.006
Diebold, F. X., & Yilmaz, K. (2014). On the network topology of variance decompositions: Measuring the connectedness of financial firms. Journal of Econometrics, 182, 119-134. doi:10.1016/j.jeconom.2014.04.012
Doshi, H., Jacobs, K., & Zurita, V. (2017). Economic and financial determinants of credit risk premiums in the sovereign CDS market. Review of Asset Pricing Studies, 7, 43-80. doi:10.1093/rapstu/rax009
Dungey, M., Fry, R., Gonzalez-Hermosillo, B., & Martin, V. L. (2005). Empirical modelling of contagion: A review of methodologies. Quantitative Finance, 5, 9-24. doi:10.1080/14697680500142045
Eichengreen, B., Rose, A. K., & Wyplosz, C. (1996). Contagious Currency Crises: First Tests. Scandinavian Journal of Economics, 98, 463-484. doi:10.2307/3440879
Feng, Q., Sun, X., Liu, C., & Li, J. (2021). Spillovers between sovereign CDS and exchange rate markets: The role of market fear. North American Journal of Economics and Finance, 55, 1-42. doi:10.1016/j.najef.2020.101308
Forbes, K. J., & Rigobon, R. (2002). No contagion, only interdependence: measuring stock market comovements. Journal of Finance, 17, 2223-2261. doi:10.1111/0022-1082.00494
Gai, P., & Kapadia, S. (2010). Contagion in financial networks. Working Paper, Bank of England.
Guo, Y., Li, P., & Li, A. (2021). Tail risk contagion between international financial markets during COVID-19 pandemic. International Review of Financial Analysis, 73, 101649. doi:10.1016/j.irfa.2020.101649
Hui, C.-H., & Fong, T. P.-W. (2015). Price cointegration between sovereign CDS and currency option markets in the financial crises of 2007-2013. International Review of Economics and Finance, 40, 174-190. doi:10.1016/j.iref.2015.02.011
Jeanneret, A. (2018). Sovereign credit spreads under good/bad governance. Journal of Banking and Finance, 93, 230-246. doi:10.1016/j.jbankfin.2018.04.005
Karolyi, G. A., & McLaren, K. J. (2017). Racing to the exits: International transmission of funding shocks during the Federal Reserve’s taper experiment. Emerging Market Review, 32, 96-115. doi:10.1016/j.ememar.2017.05.009
Khallouli, W., & Sandretto, R. (2012). Testing for ``contagion'' of the subprime crisis on the Middle East and North African stock markets: A Markov switching EGARCH approach. Journal of Economic Integration, 27, 134-166. doi:10.11130/jei.2012.27.1.134
King, M., & Wadhwani, S. (1990). Transmission of volatility between stock markets. Review of Financial Studies, 3, 5-33. doi:10.1093/rfs/3.1.5
Koop, G., & Korobilis, D. (2014). A new index of financial conditions. European Economic Review, 71, 101-116. doi:10.1016/j.euroecorev.2014.07.002
Koop, G., Pesaran, M. H., & Potter, S. M. (1996). Impulse response analysis in nonlinear multivariate models. Journal of Econometrics, 74, 119-147. doi:10.1016/0304-4076(95)01753-4
Le, C., Dickinson, D., & Le, A. (2022). Sovereign risk spillovers: A network approach. Journal of Financial Stability, 60, 101006. doi:10.1016/j.jfs.2022.101006
Lin, W. L., Engle, R., & Ito, T. (1994). Do bulls and bears move across borders? International transmission of stock returns and volatility. Review of Financial Studies, 7, 507–538. doi:10.1093/rfs/7.3.507
Longstaff, F. A., Pan, J., Pedersen, L. H., & Singleton, K. J. (2011). How sovereign is sovereign credit risk? American Economic Journal: Macroeconomics, 3, 75-103. doi:10.3386/w13658
Masson, P. (1998). Contagion: Monsoonal Effects, Spillovers, and Jumps between Multiple Equilibria. Working Paper, IMF.
Naifar, N., & Shahzad, S. J. (2022). Tail event-based sovereign credit risk transmission network during COVID-19 pandemic. Finance Research Letters, 45, 102182. doi:10.1016/j.frl.2021.102182
Pesaran, M. H., & Shin, Y. (1998). Generalized impulse response analysis in linear multivariate models. Economics Letters, 58, 17-29. doi:10.1016/S0165-1765(97)00214-0
Primiceri, G. E. (2005). Time varying structural vector autoregressions and monetary policy. Review of Economic Studies, 72, 821-852. doi:10.1111/j.1467-937X.2005.00353.x
Sabkha, S., de Peretti, C., & Hmaied, D. M. (2019). International risk spillover in sovereign credit markets: An empirical analysis. Managerial Finance, 45, 1020-1040. doi:10.1108/MF-11-2017-0490
Srivastava, S., Lin, H., Premachandra, I. M., & Roberts, H. (2016). Global risk spillover and the predictability of sovereign CDS spread: International evidence. International Review of Economics and Finance, 41, 371-390. doi:10.1016/j.iref.2015.10.047