Volatility spillovers in the European bank CDS market

Abstract

From the 2007 subprime crisis to the recent Eurozone debt crisis, the banking industry has experienced terrible financial instability with increasing volatility levels of bank default probability. Using European CDS spreads data from January 2006 to March 2013, this paper sheds light on the impact of three recent significant events of credit risk volatility transmission between, firstly, Eurozone and non-Eurozone banks, and then between distressed peripheral and core countries inside the Eurozone. We employ an asymmetric multivariate BEKK model to measure cross-market volatility spillovers. We find that both recent crises are distinct episodes. The global financial crisis that originated outside Europe is characterized by unidirectional volatility spillovers in credit risk from inside to outside the Eurozone. By contrast, the Eurozone debt crisis is revealed to be local in nature with the euro as the key element, suggesting a financial market fragmentation within the Eurozone between distressed peripheral and non-distressed core Eurozone countries, whereas retaining the local currency has acted as a firewall.

Media sentiment and CDS spread spillovers: Evidence from the GIIPS countries

“…Finally, our work is related to the literature on spillovers across CDS markets (e.g., Alemany, Ballester and Urteaga, 2015). Elkhaldi et al (2014) investigate contagion spillovers between macroeconomic and market factors across peripheral and core countries in Europe.…”

Subordinate Resolution ‐‐ An Empirical Analysis of European Union Subsidiary Banks

“…First, banks have decreased their reliance on senior debt over time increasing the likelihood of depositor bail‐in. Second, in line with large increases in bank credit spreads observed with the introduction of bail‐in (Alemany et al, ), markets require a greater yield on bank debt, altering the attractiveness of debt as a funding source for banks.…”

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“…They show a significant volatility spillover from distressed to central Eurozone economies leading to a significant impact on the default swap risk premia. Using an asymmetric multivariate BEKK model, Alemany et al (2015) show that the global financial crisis that originated outside Europe is characterised by unidirectional volatility spillovers in credit risk from inside to outside the Eurozone. By contrast, the Eurozone debt crisis is revealed to be local in nature with the Euro as the key element, suggesting a financial market fragmentation within the Eurozone between distressed peripheral and non-distressed core Eurozone countries, whereas retaining the local currency has acted as a firewall.…”