What Makes Systemic Risk Systemic? Contagion and Spillovers in the International Sovereign Debt Market

32 Pages Posted: 11 Apr 2014 Last revised: 29 Jul 2022

Date Written: April 8, 2014

Abstract

This working paper was written by Eliza Wu (University of Sydney), Magdalena Erdem (Bank for International Settlements), Elena Kalotychou (City University London) and Eli Remolona (Bank for International Settlements).

We analyze the cross-border propagation of systemic risk in the international sovereign debt market. Using daily data on CDS spreads for 67 sovereign borrowers from 2002 to 2013 we define sovereign credit events as those in which the spread widens by more than 99.9% of all spread changes within regions. We find a total of 89 such credit events, most of them taking place after 2007. We analyze contagion by studying the immediate effects of these events on CDS spreads of other sovereigns within the region and in the rest of the world. Although a few events had effects that were global in scope, we find that such “fast and furious” contagion has been by and large a regional phenomenon. To analyze “slow burn” spillover effects, we extract the first principal component of CDS spread changes to identify a global sovereign risk factor. The corresponding loadings on this factor then serve to measure the sensitivity of individual sovereign CDS spreads to the global factor. We allow these loadings to vary over time and interpret them as measures of vulnerability to global systemic risk. We find that the global “slow-burn” spillover of credit events works through the global risk factor rather than through sovereign obligors’ systemic vulnerabilities. While the global factor and regional vulnerabilities are both influenced by investors’ risk appetites, such vulnerabilities also depend on economic fundamentals, including the sovereign’s level of government debt.

Keywords: Systemic Risk, Credit Event, Sovereign Risk, Contagion, Spillover, Credit Default Swap, Debt Crisis, Subprime Crisis, Global Factor

JEL Classification: G15, F30, F31

Suggested Citation

Submitter, Hong Kong Institute for Monetary and Financial Research, What Makes Systemic Risk Systemic? Contagion and Spillovers in the International Sovereign Debt Market (April 8, 2014). Hong Kong Institute for Monetary and Financial Research (HKIMR) Research Paper WP No. 07/2014, Journal of International Money and Finance, Vol. 69, No. C, 2016, Available at SSRN: https://ssrn.com/abstract=2423184 or http://dx.doi.org/10.2139/ssrn.2423184

Hong Kong Institute for Monetary and Financial Research Submitter (Contact Author)

Hong Kong Institute for Monetary and Financial Research ( email )

Units 1005-1011, 10th Floor, One Pacific Place
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Hong Kong
China

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