Hawkes-diffusion process and the conditional probability of defaults in the Eurozone

Jungmu Kim, Yuen Jung Park and Doojin Ryu

Physica A: Statistical Mechanics and its Applications, 2016, vol. 449, issue C, 301-310

Abstract: This study examines market information embedded in the European sovereign CDS (credit default swap) market by analyzing the sovereign CDSs of 13 Eurozone countries from January 1, 2008, to February 29, 2012, which includes the recent Eurozone debt crisis period. We design the conditional probability of defaults for the CDS prices based on the Hawkes-diffusion process and obtain the theoretical prices of CDS indexes. To estimate the model parameters, we calibrate the model prices to empirical prices obtained from individual sovereign CDS term structure data. The estimated parameters clearly explain both cross-sectional and time-series data. Our empirical results show that the probability of a huge loss event sharply increased during the Eurozone debt crisis, indicating a contagion effect. Even countries with strong and stable economies, such as Germany and France, suffered from the contagion effect. We also find that the probability of small events is sensitive to the state of the economy, spiking several times due to the global financial crisis and the Greek government debt crisis.

Keywords: Contagion effect; Hawkes-diffusion process; Credit default swap; Top-down approach; Sovereign CDS (search for similar items in EconPapers)
Date: 2016
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:phsmap:v:449:y:2016:i:c:p:301-310

DOI: 10.1016/j.physa.2015.12.087

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