What Drives Systemic Credit Risk? Evidence from the US State CDS Market
The Journal of Fixed Income 28 (4)
66 Pages Posted: 27 Jul 2017 Last revised: 7 Jan 2020
Date Written: July 22, 2017
The root cause of systemic risk is an issue of on-going debate. We document evidence that common shocks of macroeconomic fundamentals are key driver of US state systemic credit risk. A structure model is developed to show importance of economic fundamentals. We find that macroeconomic variables have higher explanatory power for the temporal variation in state credit spreads and its systemic component than do financial market variables. Empirical evidence points to the macroeconomic linkages, not financial linkages, as the dominating source of systemic credit risk, and suggests that state credit risk is mainly driven by the weakness in economic fundamentals.
Keywords: Systemic Credit Risk, State Fiscal Problems, Macroeconomic Fundamentals, Economic Beta, Credit Spread Comovement, Kalman Filter
JEL Classification: G01, G12
Suggested Citation: Suggested Citation