Disentangling Contagion Among Sovereign CDS Spreads During the European Debt Crisis

38 Pages Posted: 17 Oct 2013

Date Written: October 17, 2013

Abstract

During the last crisis, developed economies’ sovereign Credit Default Swap (hereafter CDS) premia have gained in importance as a tool for approximating credit risk. In this paper, we fit a dynamic factor model to decompose the sovereign CDS spreads of ten OECD economies into three components: a common factor, a second factor driven by European peripheral countries and an idiosyncratic component. We use this decomposition to propose a novel methodology based on the real-time estimates of the model to characterize contagion among the ten series. Our procedure allows the country that triggers contagion in each period, which can be any peripheral economy, to be disentangled. According to our findings, since the onset of the sovereign debt crisis, contagion has played a non-negligible role in the European peripheral countries, which confirms the existence of significant financial linkages between these economies.

Keywords: sovereign Credit Default Swaps, contagion, dynamic factor models, credit risk

JEL Classification: C32, G01, G15

Suggested Citation

Broto, Carmen and Perez-Quiros, Gabriel, Disentangling Contagion Among Sovereign CDS Spreads During the European Debt Crisis (October 17, 2013). Banco de Espana Working Paper No. 1314, Available at SSRN: https://ssrn.com/abstract=2341518 or http://dx.doi.org/10.2139/ssrn.2341518

Carmen Broto (Contact Author)

Banco de España ( email )

Alcala 50
Madrid 28014
Spain

Gabriel Perez-Quiros

Banco de España ( email )

Madrid 28014
Spain

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