Mutual Excitation in Eurozone Sovereign CDS

SAFE Working Paper No. 51

36 Pages Posted: 19 May 2014 Last revised: 2 Jun 2014

See all articles by Yacine Ait-Sahalia

Yacine Ait-Sahalia

Princeton University - Department of Economics; National Bureau of Economic Research (NBER)

Roger J. A. Laeven

University of Amsterdam - Department of Quantitative Economics (KE)

Loriana Pelizzon

Goethe University Frankfurt - Faculty of Economics and Business Administration; Goethe University Frankfurt - Research Center SAFE; Ca Foscari University of Venice

Date Written: May 14, 2014

Abstract

We study self- and cross-excitation of shocks in the Eurozone sovereign CDS market. We adopt a multivariate setting with credit default intensities driven by mutually exciting jump processes, to capture the salient features observed in the data, in particular, the clustering of high default probabilities both in time (over days) and in space (across countries). The feedback between jump events and the intensity of these jumps is the key element of the model. We derive closed-form formulae for CDS prices, and estimate the model by matching theoretical prices to their empirical counterparts. We find evidence of self-excitation and asymmetric cross-excitation. Using impulse-response analysis, we assess the impact of shocks and a potential policy intervention not just on a single country under scrutiny but also, through the effect on cross-excitation risk which generates systemic sovereign risk, on other interconnected countries.

Keywords: CDS, Sovereign risk, Systemic risk, Jumps, Feedback, Hawkes processes, Mutually exciting processes, Impulse-response

JEL Classification: C13, G12

Suggested Citation

Ait-Sahalia, Yacine and Laeven, Roger Jean Auguste and Pelizzon, Loriana, Mutual Excitation in Eurozone Sovereign CDS (May 14, 2014). SAFE Working Paper No. 51. Available at SSRN: https://ssrn.com/abstract=2438625 or http://dx.doi.org/10.2139/ssrn.2438625

Yacine Ait-Sahalia

Princeton University - Department of Economics ( email )

Fisher Hall
Princeton, NJ 08544
United States
609-258-4015 (Phone)
609-258-5398 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Roger Jean Auguste Laeven

University of Amsterdam - Department of Quantitative Economics (KE) ( email )

Valckenierstraat 65-67
Amsterdam, 1018 XE
Netherlands
+31 20 525 4252 (Phone)

HOME PAGE: http://www.rogerlaeven.com

Loriana Pelizzon (Contact Author)

Goethe University Frankfurt - Faculty of Economics and Business Administration ( email )

Theodor-W.-Adorno-Platz 3
Frankfurt am Main, D-60323
Germany

Goethe University Frankfurt - Research Center SAFE ( email )

Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60323
Germany

HOME PAGE: http://www.safe-frankfurt.de

Ca Foscari University of Venice ( email )

Dorsoduro 3246
Venice, Veneto 30123
Italy

Register to save articles to
your library

Register

Paper statistics

Downloads
268
rank
108,074
Abstract Views
1,267
PlumX Metrics