Conditional Probabilities and Contagion Measures for Euro Area Sovereign Default Risk

Xin Zhang, Bernd Schwaab and Andre Lucas

Tinbergen Institute Discussion Papers from Tinbergen Institute

Abstract: We propose a novel empirical framework to assess the likelihood of joint and conditional failure for Euro area sovereigns. Our model is based on a dynamic skewed-t copulawhich captures all the salient features of the data, including skewed and heavy-tailed changes in the price of CDS protection against sovereign default, as well as dynamicvolatilities and correlations to ensure that failure dependence can increase in times of stress. We apply the framework to Euro area sovereign CDS spreads from 2008 tomid-2011. Our results reveal significant time-variation in risk dependence and considerable spill-over effects in the likelihood of sovereign failures. We also investigatedistress dependence around a key policy announcement by Euro area heads of state on May 9, 2010, and demonstrate the importance of capturing higher-order time-varyingmoments during times of crisis for the correct assessment of interacting risks.

Keywords: sovereign credit risk; higher order moments; time-varying parameters; financial stability (search for similar items in EconPapers)
JEL-codes: C32 G32 (search for similar items in EconPapers)
Date: 2011-12-13, Revised 2012-06-28
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Citations: View citations in EconPapers (25)

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Related works:
Journal Article: Conditional probabilities and contagion measures for euro area sovereign default risk (2012)
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Persistent link: https://EconPapers.repec.org/RePEc:tin:wpaper:20110176

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