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The Impacts of Financial Crisis on Sovereign Credit Risk Analysis in Asia and Europe

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Author Info

  • Min Zhang

    (School of Management and Engineering, Nanjing University, China)

  • Adam W. Kolkiewicz

    (Department of Statistics & Actuarial Science, University of Waterloo, Canada)

  • Tony S. Wirjanto

    (Department of Statistics & Actuarial Science, School of Accounting & Finance, University of Waterloo, Canada)

  • Xindan Li

    (School of Management and Engineering, Nanjing University, China)

Abstract

We investigate the nature of sovereign credit risk for selected Asian and European countries based on a set of sovereign CDS data over an eight-year period that includes the episode of the 2008-2009 global financial crisis. The principal component analysis results indicate that there exists strong commonality in sovereign credit risk among the countries studied in this paper following the crisis. In addition, the regression results show that commonality is importantly associated with both local and global financial and economic variables. There are also important differences in the sovereign of credit risk behavior between Asian and European countries. Specifically, we find that foreign reserve, global stock market, and volatility risk premium, affect Asian and European sovereign credit risks in the opposite direction. Lastly, we model the arrival rates of credit events as a square-root diffusion process from which a pricing model is constructed and estimated over pre and post-crisis periods. The resulting model is used to decompose credit spreads into risk premium and credit-event components. For most countries in our study, credit-event components weight more than risk-premiums, suggesting that, in the long term, investors are perhaps more concerned with the prospect of sovereign-specific credit events than systemic sovereign credit risks.

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Paper provided by The Rimini Centre for Economic Analysis in its series Working Paper Series with number 62_13.

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Date of creation: Dec 2013
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Handle: RePEc:rim:rimwps:62_13

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