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Conditional euro area sovereign default risk

Author

Listed:
  • 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.

Suggested Citation

  • Lucas, André & Schwaab, Bernd & Zhang, Xin, 2013. "Conditional euro area sovereign default risk," Working Paper Series 269, Sveriges Riksbank (Central Bank of Sweden).
  • Handle: RePEc:hhs:rbnkwp:0269
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    References listed on IDEAS

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    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    sovereign credit risk; higher order moments; time-varying parameters; financial stability;
    All these keywords.

    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; State Space Models
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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