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Variance decomposition of sovereign CDS spreads

  • Zalán Kocsis

    ()

    (Magyar Nemzeti Bank (central bank of Hungary))

  • Dénes Nagy

    ()

    (Széchenyi Tõkealap-kezelõ Zrt. (Széchenyi Venture Capital Fund))

In this paper we analyse the information content of correlations between daily changes in CDS spreads. Using factor analysis, we can break down the variance of CDS spreads into global, regional and country-specific components. Our results confirm the finding of other studies, namely that there is a strong global factor underlying credit risk spreads. Comparison of different time samples reveals that the global correlation of spreads has become stronger during the financial crisis; at present, the global factor universally affects emerging and developed countries. CDS spreads are most strongly correlated with other countries in geographically interpretable regional country groups. The Hungarian CDS spread generally follows the global factor; in recent years, the escalating crisis on the periphery of the euro area has also affected the country’s spreads. From the summer of 2010 until the end of the year, country-specific events led to a considerable deterioration in Hungary’s risk assessment. However, the shift in the government’s fiscal policy stance in early 2011 restored most of the lost investor confidence.

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Article provided by Magyar Nemzeti Bank (the central bank of Hungary) in its journal MNB Bulletin.

Volume (Year): 6 (2011)
Issue (Month): 3 (October)
Pages: 36-50

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Handle: RePEc:mnb:bullet:v:6:y:2011:i:3:p:36-50
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  1. Edwards, Sebastian, 1984. "LDC Foreign Borrowing and Default Risk: An Empirical Investigation, 1976-80," American Economic Review, American Economic Association, vol. 74(4), pages 726-34, September.
  2. Barry Eichengreen & Ashoka Mody, 1998. "What Explains Changing Spreads on Emerging-Market Debt: Fundamentals or Market Sentiment?," NBER Working Papers 6408, National Bureau of Economic Research, Inc.
  3. Edwards, Sebastian, 1986. "The pricing of bonds and bank loans in international markets : An empirical analysis of developing countries' foreign borrowing," European Economic Review, Elsevier, vol. 30(3), pages 565-589, June.
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  10. Sebastian Edwards, 1983. "LDC's Foreign Borrowing and Default Risk: An Empirical Investigation," NBER Working Papers 1172, National Bureau of Economic Research, Inc.
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  14. Eli M. Remolona & Michela Scatigna & Eliza Wu, 2008. "A ratings-based approach to measuring sovereign risk," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 13(1), pages 26-39.
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