Extracting the sovereigns’ CDS market hierarchy: a correlation-filtering approach
AbstractSince correlation may be interpreted as a measure of the influence across time-series, it may be conveniently mapped into a distance and into a weighted adjacency matrix. Based on such matrix, network theory has attempted to filter out the noise in correlation matrices by extracting the dominant hierarchy (i.e. the strongest linear-dependence signals) within time-series. The aim of this brief paper is to find the current hierarchy in the sovereigns’ CDS market after the structural shift caused by the failure of Lehman Brothers. Thus, based on two different correlation-into-distance mapping techniques and a minimal spanning tree-based correlation-filtering methodology on 36 sovereign CDS spread time-series, the target is to identify which sovereigns are providing the strongest –less noisy- and most informative signals. The resulting sovereigns’ CDS market hierarchy agrees with prior findings of Gilmore et al. (2010) regarding sovereigns’ bonds market, such as the importance of geographical clustering and the idiosyncratic nature of Japan and United States. Additionally, results (i) confirm that a small set of common factors affect the entire system; (ii) identify the relevance of credit rating clustering; (iii) identify Russia, Turkey and Brazil as regional benchmarks; (iv) suggest that lower-medium grade rated sovereigns are the most influential, but also the most prone to contagion; and (v) suggest the existence of a “Latin American common factor”.
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Bibliographic InfoPaper provided by BANCO DE LA REPÚBLICA in its series BORRADORES DE ECONOMIA with number 010749.
Date of creation: 22 May 2013
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- Carlos Eduardo León Rincón & Karen Julieth Leiton & Jhonatan Perez Villalobos, 2013. "Extracting the sovereigns’ CDS market hierarchy: a correlation-filtering approach," Borradores de Economia 766, Banco de la Republica de Colombia.
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- Coudert, V. & Gex, M., 2010. "Credit default swap and bond markets: which leads the other?," Financial Stability Review, Banque de France, issue 14, pages 161-167, July.
- Carlos León & Karen Leiton & Alejandro Reveiz, 2012.
"Investment Horizon Dependent CAPM: Adjusting beta for long-term dependence,"
BORRADORES DE ECONOMIA
009909, BANCO DE LA REPÚBLICA.
- Carlos León & Karen Leiton & Alejandro Reveiz, 2012. "Investment horizon dependent CAPM: Adjusting beta for long-term dependence," Borradores de Economia 730, Banco de la Republica de Colombia.
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