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Conditional euro area sovereign default risk

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Author Info

  • Lucas, André

    ()
    (VU University Amsterdam and Tinbergen Institute)

  • Schwaab, Bernd

    ()
    (European Central Bank)

  • Zhang, Xin

    ()
    (Research Department, Central Bank of Sweden)

Abstract

We propose an empirical framework to assess the likelihood of joint and conditional sovereign default from observed CDS prices. Our model is based on a dynamic skewed-t distribution that captures all salient features of the data, including skewed and heavytailed changes in the price of CDS protection against sovereign default, as well as dynamic volatilities and correlations that ensure that uncertainty and risk dependence can increase in times of stress. We apply the framework to euro area sovereign CDS spreads during the euro area debt crisis. Our results reveal significant time-variation in distress dependence and spill-over effects for sovereign default risk. We investigate market perceptions of joint and conditional sovereign risk around announcements of Eurosystem asset purchases programs, and document a strong impact on joint risk.

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Bibliographic Info

Paper provided by Sveriges Riksbank (Central Bank of Sweden) in its series Working Paper Series with number 269.

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Length: 45 pages
Date of creation: 01 May 2013
Date of revision:
Handle: RePEc:hhs:rbnkwp:0269

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Postal: Sveriges Riksbank, SE-103 37 Stockholm, Sweden
Phone: 08 - 787 00 00
Fax: 08-21 05 31
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Web page: http://www.riksbank.com/
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Keywords: sovereign credit risk; higher order moments; time-varying parameters; financial stability;

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References

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  1. Creal, Drew & Koopman, Siem Jan & Lucas, André, 2011. "A Dynamic Multivariate Heavy-Tailed Model for Time-Varying Volatilities and Correlations," Journal of Business & Economic Statistics, American Statistical Association, vol. 29(4), pages 552-563.
  2. repec:taf:jnlbes:v:30:y:2012:i:2:p:212-228 is not listed on IDEAS
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  10. Jun Pan & Kenneth J. Singleton, 2008. "Default and Recovery Implicit in the Term Structure of Sovereign "CDS" Spreads," Journal of Finance, American Finance Association, vol. 63(5), pages 2345-2384, October.
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  21. Xin Zhang & Drew Creal & Siem Jan Koopman & Andre Lucas, 2011. "Modeling Dynamic Volatilities and Correlations under Skewness and Fat Tails," Tinbergen Institute Discussion Papers 11-078/2/DSF22, Tinbergen Institute.
  22. Franses, Philip Hans & Lucas, Andre, 1998. "Outlier Detection in Cointegration Analysis," Journal of Business & Economic Statistics, American Statistical Association, vol. 16(4), pages 459-68, October.
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  24. Oren Sussman & Alexander Guembel, 2005. "Sovereign Debt Without Default Penalties," OFRC Working Papers Series 2005fe17, Oxford Financial Research Centre.
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