A Revisit to Sovereign Risk Contagion in Eurozone with Mutual Exciting Regime-Switching Model

43 Pages Posted: 15 Sep 2022 Last revised: 11 Nov 2022

See all articles by Shuyi Ge

Shuyi Ge

Nankai University - Department of Finance

Date Written: August 29, 2022

Abstract

This paper proposes a new mutual exciting regime-switching model where crises can spread contagiously across countries. Each country has its own hidden stochastic process that determines whether it is in a normal or crisis regime. The mutual-excitation component allows interactions in the Markov chains, and a crisis in one country could increase the likelihood of a crisis in another country. Using this new approach, I revisit the sovereign risk contagion in the euro area. I find striking shifts in market pricing functions for the sovereign bond spreads. Multi-country contagion plays a dominant role in driving such shifts, while common risk factors and country-specific fundamentals are less important.

Keywords: Contagion, Interdependence, Regime-switching, Mutual-excitation, Sovereign credit risk

JEL Classification: C24, C58, F36, G12, G15

Suggested Citation

Ge, Shuyi, A Revisit to Sovereign Risk Contagion in Eurozone with Mutual Exciting Regime-Switching Model (August 29, 2022). Available at SSRN: https://ssrn.com/abstract=4202998 or http://dx.doi.org/10.2139/ssrn.4202998

Shuyi Ge (Contact Author)

Nankai University - Department of Finance ( email )

94 Weijin Road
Tianjin, 300071
China

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