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A multilevel factor approach for the analysis of CDS commonality and risk contribution

Carlos Vladimir Rodríguez-Caballero () and Massimiliano Caporin ()
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Carlos Vladimir Rodríguez-Caballero: Mexico Autonomous Institute of Technology (ITAM) and CREATES, Postal: Department of Statistics, Río Hondo No.1, Col. Progreso, Tizapán, Álvaro Obregón, CDMX. 01080. México

Authors registered in the RePEc Author Service: Carlos Vladimir Rodríguez Caballero ()

CREATES Research Papers from Department of Economics and Business Economics, Aarhus University

Abstract: We introduce a novel multilevel factor model that allows for the presence of global and pervasive factors, local factors and semi-pervasive factors, and that captures common features across subsets of the variables of interest. We develop a model estimation procedure and provide a simulation experiment addressing the consistency of our proposal. We complete the analyses by showing how our multilevel model might explain on the commonality across CDS premiums at the global level. In this respect, we cluster countries by either the Debt/GDP ratio or by sovereign ratings. We show that multilevel models are easier to interpret compared with factor models based on principal component analysis. Finally, we experiment how the multilevel model might allow the recovery of the risk contribution due to the latent factors within a basket of country CDS.

Keywords: multilevel factor models; risk contribution; CDS risk factors (search for similar items in EconPapers)
JEL-codes: C32 C38 E44 F30 G15 (search for similar items in EconPapers)
Date: 2018-12-11
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