Liquidity Contagion: The Emerging Sovereign Debt Markets Example

Posted: 9 Feb 2013

See all articles by Serge Darolles

Serge Darolles

Université Paris Dauphine - DRM-CEREG

Jérémy Dudek

National Institute of Statistics and Economic Studies (INSEE) - Laboratory of Finance and Insurance; National Institute of Statistics and Economic Studies (INSEE) - Center for Research in Economics and Statistics (CREST); Université Paris Dauphine - Department of Finance

Gaëlle Le Fol

Université Paris-Dauphine, PSL Research University, CNRS, UMR 7088, DRM, Finance, 75016 Paris, France; National Institute of Statistics and Economic Studies (INSEE) - Center for Research in Economics and Statistics (CREST)

Date Written: February 8, 2013

Abstract

Financial markets are today so interconnected that they are fragile to contagion. Massive investment funds with very short horizons in -and out- flows can generate contagion effects between markets. Since 2010, investors are willing to get a liquid exposure to the EM sovereign debt. As a consequence, some asset management firms started to propose products to track the performance of this asset class. However in that case, the fund manager faces a mismatch of liquidity between assets and liabilities and needs some tools to manage the liquidity of his investments. The main contribution of this paper is the analysis of contagion looking at common market liquidity problems to detect funding liquidity problems. Using the CDS Bond Spread basis as a liquidity indicator and a state space model with time-varying volatility specification, we show that during the 2007-2008 financial crisis, there exist pure contagion effects both in terms of price and liquidity on the emerging sovereign debt market. This result has strong implication since the main risk for an asset manager is to get stuck with an unwanted position due to a dry-up of market liquidity.

Keywords: Emerging Markets, Sovereign Debt Market, Liquidity Risk Management, Liquidity, Contagion Effects, Regime Switching models

JEL Classification: G01, G15, C01, C32

Suggested Citation

Darolles, Serge and Dudek, Jérémy and Le Fol, Gaëlle, Liquidity Contagion: The Emerging Sovereign Debt Markets Example (February 8, 2013). Available at SSRN: https://ssrn.com/abstract=2213825 or http://dx.doi.org/10.2139/ssrn.2213825

Serge Darolles

Université Paris Dauphine - DRM-CEREG ( email )

place du Maréchal de Lattre de Tassigny
cedex 16
Paris, 75775
France

Jérémy Dudek (Contact Author)

National Institute of Statistics and Economic Studies (INSEE) - Laboratory of Finance and Insurance ( email )

France

National Institute of Statistics and Economic Studies (INSEE) - Center for Research in Economics and Statistics (CREST) ( email )

15 Boulevard Gabriel Peri
Malakoff Cedex, 1 92245
France

Université Paris Dauphine - Department of Finance

Place du Maréchal de Lattre de Tassigny
Paris Cedex 16, 75775
France

Gaëlle Le Fol

Université Paris-Dauphine, PSL Research University, CNRS, UMR 7088, DRM, Finance, 75016 Paris, France ( email )

Place du Maréchal de Lattre de Tassigny
Paris Cedex 16, 75775
France

National Institute of Statistics and Economic Studies (INSEE) - Center for Research in Economics and Statistics (CREST) ( email )

15 Boulevard Gabriel Peri
Malakoff Cedex, 1 92245
France

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