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The Credit Default Swap market contagion during recent crises: international evidence

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Abstract

This paper analyzes Credit Default Swap spread dynamics to determine whether the sovereign Credit Default Swap market is subject to contagion effects. Analysis is performed on credit spreads data from 35 worldwide countries belonging to four different economic categories over a period from 2006 until 2014, covering the subprime crisis and the European sovereign debt crisis. A novel approach is proposed to estimate the Dynamic Conditional Correlations between CDS spreads using the AR(1)-FIEGARCH(1,d,1)-DCC model. Based on our findings, we put a slant on the financial market vulnerability, reinforced by contagion effects during the different phases of the crises. Furthermore, analysis of each country solely shows that contagion effects are sterner during the Eurozone crisis compared to the global financial crisis and that the level of exposure to crises differs across global markets and regions. Yet our approach provides evidences that crises spread to countries across the world regardless their economic status or geographical positions.

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Notes

  1. For a complete survey on different contagion definitions, see Missio and Watzka (2011) whom summarize all the existing definitions in the literature and draw up a report of the four most used ones: (i) there is a financial contagion when the probability of a crisis’s appearance in one country increases considerably after the occurrence of a crisis in another country; (ii) contagion phenomenon is observed when several financial assets’ volatility across markets of one country simultaneous rise; (iii) contagion is defined as a sudden modification in financial assets’ prices without any economic explanations related to fundamentals and (iv) the significant increase in prices co-movements across international markets implies a contagion phenomenon.

  2. The impulse response function (IRF) provides information on the current and future evolution (range and duration) of a time series, following a financial shock on an innovation.

  3. Portugal, Ireland, Italy, Greece and Spain.

  4. The PIIGS denotes the 5 European countries that suffer the most from indebtedness and represent a weak growth prospects with high unemployment rates. They are called, somewhat disdainfully, the “Club Med” countries for their fiscal laxity and the fragility of their economies.

  5. Some empirical studies show that developed countries are more likely to constitute a transmission channel of crises and suggest that the propagation reasons of turmoil in industrial countries differ from those in emerging countries (Caramazza et al. 2004).

  6. These are all economies which, by their development strategies, have experienced a major industrial take-off over the last 20–40 years.

  7. These countries are characterized by a fast economic growth but still have not reached the level of GDP per capital of the developed countries. Unlike the newly industrialized countries, emerging countries have already had a significant industrial sector or developement in sectors other than industry.

  8. We use different criteria of countries’ economic classification (the NU, the CIA World Factbook, the IMF and the World Bank criteria) as to have a sample of sufficient size in each category.

  9. See also the Federal Reserve Bank of ST. Louis’s report entitled ”The Financial crisis: a time-line of events and policy actions” (2009).

  10. Lehman Brothers, the 4th biggest investment bank in the USA, has been declared Bankrupt in September 15th, 2008.

  11. \(RMSE_v=\sqrt{\frac{1}{n}\sum _{i=1}^{n}(x^2_{i+1}-\sigma ^2_{i+1}(\lambda ))^2}\).

  12. The Ljung–Box tests (Q-statistics), the Residual-Based Diagnostic, the Nyblom test for stability and the Adjusted Pearson Godness-of-fit test. See the Review-Empirical Appendix of Fantazzini (2011) for a detailed description of theses diagnostic tests.

  13. The differencing operator is defined by its Maclaurin series expansion. In the branch of mathematical analysis, a Taylor series of a function f (at a single point a) is a representation of power series calculated from the successive values of f and its derivatives at the point a. If \(a=0\) then the series is so-called Maclaurin series expansion. \((1-L)^d=(1-d)\sum _{h=1}^{\infty }\varGamma (h-d)\varGamma (1-d)^{-1}\varGamma (h+1)^{-1}L^h=1-\delta _d(L)\) with \(\varGamma\) is the gamma function (it is a special function extending the factorial function to the whole set of complex numbers, hence the name of function of complex variables.).

  14. See also Engle (2002) and Engle and Kelly (2012) for further DCC estimation methods. They propose another class of multivariate model allowing some new specifications in the correlation matrix calculation.

  15. Conrad et al. (2011) present a different formulation of the multivariate DCC model and apply it to study the contagion effect on the national stock market.

  16. According to Eurostat data, Greece has recorded the largest public indebtedness increase in the European Union countries during the sample period. Greek public debt has increased by \(65\%\) from \(106.1\%\) of GDP in 2006 to \(175.1\%\) of GDP in early 2014.

  17. According to Robinson and Henry (1999) and Geweke and Porter-Hudak (1983), the use of an autoregressive fractionally integrated moving average for the volatility model is suitable when time series exhibit long memory behavior.

  18. Moreover, these results do not really make sense, especially for Denmark, the Netherlands and Norway during the pre-crisis period probably due to some statistical artefact.

  19. Results are not reported here, however, they can be provided upon request to the corresponding author.

  20. According to Dimitriou et al. (2013), when d parameter is greater than 0.5 and highly significant, which means a high degree of persistence in the behavior of the financial markets, this indicates that the persistence of the shock on the conditional volatility of financial assets returns follows a hyperbolic rate of decay.

  21. The GFCI is a financial report published twice a year. The aim of this index is to examine countries’ financial competitiveness. It rates and ranks more than 87 major financial centers in terms of their reactions to episodes of economic instability. Over the last several years, New York and London remain the main occupiers of the first place as the world’s most economically powerful platform.

  22. According to the OECD report (2016), the USA external demand for exports and imports exceeded 12 million US dollars.

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Authors and Affiliations

  1. Univ Lyon, Université Claude Bernard Lyon, Institut de Science Financière et d’Assurances, Laboratoire de Sciences Actuarielle et Financière SAF-EA2429, 69366, Lyon, France

    Saker Sabkha & Christian de Peretti

  2. Université de Carthage, Institut des Hautes Études Commerciales de Carthage, Laboratoire d’Économie et de Finance Appliquée (LEFA), 2016, Tunis, Tunisia

    Saker Sabkha & Dorra Hmaied

  3. LEO, Université d’Orléans, CNRS, UMR 7322, 45067, Orléans, France

    Christian de Peretti

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  1. Saker Sabkha
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Correspondence to Saker Sabkha.

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Sabkha, S., de Peretti, C. & Hmaied, D. The Credit Default Swap market contagion during recent crises: international evidence. Rev Quant Finan Acc 53, 1–46 (2019). https://doi.org/10.1007/s11156-018-0741-6

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