International risk spillover in sovereign credit markets: an empirical analysis
Christian de Peretti and
Dorra Mezzez Hmaied
Managerial Finance, 2019, vol. 45, issue 8, 1020-1040
Purpose - The purpose of this paper is to study the volatility spillover among 33 worldwide sovereign Credit Default Swap (CDS) markets and their underlying bond markets. Design/methodology/approach - In contrast to prior studies, the authors incorporate heteroscedasticity, asymmetric leverage effects and long-memory features of sovereign credit spreads simultaneously through a bivariate FIEGARCH model and a Bayesian cointegrated vector autoregressive model. Findings - Similar to the literature, the findings confirm that strong evidence of credit risk spillover between credit markets is accentuated during two recent crisis periods. However, the country-by-country analysis indicates that countries exhibit different sensitivity levels and divergent reactions to financial shocks. Further, the authors show that the bidirectional interrelationship evolves over time and across countries emphasizing the necessity of time-varying national regulatory policies and trading positions. Originality/value - Based on a large data set that covers the recent two financial crises and using complex methods, the work focuses on sovereign tensions that have repercussions on banks’ solvency and refinancing conditions. Yet, the study is a hot topic since that during crisis periods in the financial markets, direct and indirect interconnections increase between sovereign risk and banking risk. Using new econometric approaches, the results show that each country exhibits a different behavior toward the credit risk which is relevant to both portfolio managers and policy makers. The time-varying spillover effects detected between markets are an accurate indicator of financial stability, allowing policy makers to put in place personalized economic policies. On the other hand, markets’ participants could take advantages of the results by adjusting their trading and hedging positions on the dynamic co-movements. The findings reveal, as well, that the sovereign crisis has more weakened the global financial and banking system than the subprime crisis. The authors previously tackled the cross-country contagion phenomenon in the CDS markets, and this manuscript builds on the prior study to enhance the obtained results.
Keywords: Contagion; Dynamic conditional correlation; Bayesian cointegrated VAR; Risk spillover; Sovereign CDS and bond markets; G01; G15; F30 (search for similar items in EconPapers)
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