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Systemic Financial Turmoil: Inside the Subprime and the Eurozone Crises Quantitative Architecture and Empirics

Posted: 3 Dec 2014  

Vilimir Yordanov


Date Written: December 1, 2014


The paper investigates the Subprime and the Eurozone crises by applying to them novel general methodology for portfolio credit derivatives analytics. The latter is represented by a suitable theoretical and empirical extension of the gaining popularity in the pre-crash times abstract SPA dynamic top-down HJM model as an alternative to the Gaussian copula benchmark. If the Subprime crisis, along with many other causes, was due to an improper understanding of the CDOs, the Euro sovereign debt one, interestingly, allows to use the same construct. This is due to the fact that the common currency imposed on a union lacking common treasury and being still far from a fiscal one produces a special waterfall for the losses on the overall community sovereign debt. Rather than having the extremes, on one hand, of complete proportional loss sharing, and, on the other hand, each country to rely only on its means for debt service, an intermediate implicit priority rule becomes operative. Namely, the sovereign debt becomes a mirror image of the proportions of each country's paid-in capital in ECB with a priority tranche structure going from the bearing highest spread country (equity) to the one facing the lowest one (super senior). In both crises situations, it becomes important to well understand what drives the risky spreads and how that can be properly divided between systemic and idiosyncratic factors. This could help not only in relative value analysis, but also in extracting correctly the systemic driver and the general contagion in the system. For all that we need proper calibration and estimation techniques. We apply such controlling appropriately for the market price of risk. The empirical results allow not only to dissect the turmoil, but also to derive indicators for prediction of such extreme events.

Keywords: CDO, HJM, correlation, dependence, forward rate, hedging, sovereign debt, Eurozone crisis, Subprime crisis

JEL Classification: G01, G13

Suggested Citation

Yordanov, Vilimir, Systemic Financial Turmoil: Inside the Subprime and the Eurozone Crises Quantitative Architecture and Empirics (December 1, 2014). Available at SSRN:

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