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The Changing International Network of Sovereign Debt and Financial Institutions

52 Pages Posted: 30 Aug 2016  

Mardi H. Dungey

University of Tasmania; Financial Research Network (FIRN)

David John Harvey

University of Auckland; District Court of Auckland

Vladimir Volkov

University of Tasmania

Date Written: August 30, 2016

Abstract

We develop a theoretical and empirical framework to model the international connections between financial institutions and sovereign debt markets. By allowing for both good and poor returns on the investments of financial institutions in real economy firms and the potential for haircuts in sovereign debt-markets we show how shock transmission and the default probabilities of these entities are affected through a network of these institutions. To model the financial network empirically, directional edges are established via Granger causality tests between CDS spreads, while the weights of the edges are obtained from variance decompositions. The empirical framework nests both tests of contagion and changes in the structure of the network itself. The network is found to be "robust but fragile" meaning that either a large enough single shock, or a number of small contemporaneous shocks can result in the propagation of crises. Between 2003 and 2013 for a global model of 67 financial institutions and 40 sovereigns we show that the completeness of the network changes substantially, reflecting changes in both the number and strengths of the links between them. The resulting changes in the probability of default for sovereigns and institutions demonstrate the fragility of the combined system when under stress from alternative sources.

Keywords: network, sovereign debt, financial institutions, systemic risk, contagion

Suggested Citation

Dungey, Mardi H. and Harvey, David John and Volkov, Vladimir, The Changing International Network of Sovereign Debt and Financial Institutions (August 30, 2016). CIFR Paper No. 121/2016. Available at SSRN: https://ssrn.com/abstract=2831857

Mardi H. Dungey (Contact Author)

University of Tasmania ( email )

French Street
Sandy Bay
Tasmania, 7250
Australia

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

David John Harvey

University of Auckland ( email )

Auckland, 1010
New Zealand

District Court of Auckland ( email )

65-69 Albert Street
Auckland, 1010
New Zealand

Vladimir Volkov

University of Tasmania ( email )

French Street
Sandy Bay
Tasmania, 7250
Australia

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