European Sovereign Systemic Risk Zones

Abstract

This paper proposes a novel framework identifying sovereign systemic risk zones. We first explore the cross-dynamics of sovereign CDS in terms of time-changing contagion measures based on copulas and then assemble these measures together with country-specific fundamentals through recursive partitioning, thereby producing important leading indicators and identification of main sovereign systemic risk regimes expressed as regions in CDS spreads. Using data for Greece, Ireland, Italy, Portugal, Spain, France, Germany over the period 2008-2013, we identify three main systemic risk zones (safe, risky, high risky) also assigning specific risk thresholds to the selected leading indicators (unemployment rate, Debt/GDP, inflation, GDP growth, copula-based CDS dependencies).

Keywords: Credit default swaps, systemic risk, contagion, copula, regression trees

JEL Classification: G12, G01