Measuring connectedness of euro area sovereign risk

Rebekka Buse and Melanie Schienle

No 123, Working Paper Series in Economics from Karlsruhe Institute of Technology (KIT), Department of Economics and Management

Abstract: We introduce a method for measuring default risk connectedness of euro zone sovereign states using credit default swap (CDS) and bond data. The connectedness measure is based on an out-of-sample variance decomposition of model forecast errors. Due to its predictive nature, it can respond more quickly to crisis occurrences than common in-sample techniques. We determine sovereign default risk connectedness with both CDS and bond data for a more comprehensive picture of the system. We find evidence that several observable factors drive the difference of CDS and bonds, but both data sources still contain specific information for connectedness spill-overs. Generally, we can identify countries that impose risk on the system and the respective spill-over channels. In our empirical analysis we cover the years 2009-2014, such that recovery paths of countries exiting EU and IMF financial assistance schemes and responses to the ECB's unconventional policy measures can be analyzed.

Keywords: Variance decomposition; Sovereign risk; Connectedness; Credit default swaps; Bonds; Eurozone crisis (search for similar items in EconPapers)
JEL-codes: C32 C58 G01 G15 (search for similar items in EconPapers)
Date: 2019
New Economics Papers: this item is included in nep-eec
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Citations: View citations in EconPapers (15)

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Persistent link: https://EconPapers.repec.org/RePEc:zbw:kitwps:123

DOI: 10.5445/IR/1000092470

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