Conditional Probabilities and Contagion Measures for Euro Area Sovereign Default Risk
AbstractWe propose a novel empirical framework to assess the likelihood of joint and conditional failure for Euro area sovereigns. Our model is based on a dynamic skewed-t copulawhich captures all the salient features of the data, including skewed and heavy-tailed changes in the price of CDS protection against sovereign default, as well as dynamicvolatilities and correlations to ensure that failure dependence can increase in times of stress. We apply the framework to Euro area sovereign CDS spreads from 2008 tomid-2011. Our results reveal significant time-variation in risk dependence and considerable spill-over effects in the likelihood of sovereign failures. We also investigatedistress dependence around a key policy announcement by Euro area heads of state on May 9, 2010, and demonstrate the importance of capturing higher-order time-varyingmoments during times of crisis for the correct assessment of interacting risks.
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Bibliographic InfoPaper provided by Tinbergen Institute in its series Tinbergen Institute Discussion Papers with number 11-176/2/DSF29.
Date of creation: 13 Dec 2011
Date of revision: 28 Jun 2012
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sovereign credit risk; higher order moments; time-varying parameters; financial stability;
Find related papers by JEL classification:
- C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
- G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
This paper has been announced in the following NEP Reports:
- NEP-ALL-2011-12-19 (All new papers)
- NEP-EEC-2011-12-19 (European Economics)
- NEP-RMG-2011-12-19 (Risk Management)
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