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Extracting the sovereigns´ CDS market hierarchy: a correlation-filtering approach


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  • Carlos Eduardo Léon Rincón


  • Karen Juliet Leiton


  • Jhonatan Pérez Villalobos



Since 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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Paper provided by BANCO DE LA REPÚBLICA in its series BORRADORES DE ECONOMIA with number 010749.

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Length: 26
Date of creation: 22 May 2013
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Handle: RePEc:col:000094:010749

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Keywords: correlation; minimal spanning tree; correlation-filtering; sovereign; credit default swap;

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  1. 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.
  2. 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.
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