Sovereign Credit Risk Co‐Movements in the Eurozone: Simple Interdependence or Contagion?

• DOI: http://doi.org/10.1111/infi.12099
• Published date: 01 December 2016
• Date: 01 December 2016
• Author: Lena Tonzer,Manuel Buchholz

Sovereign Credit Risk

Co-Movements in the Eurozone:

Simple Interdependence or

Contagion?

Manuel Buchholz and Lena Tonzer

Halle Institute for Economic Research (IWH), Halle (Saale), Germany

Abstract

We investigate credit risk co-movements and contagion in the sovereign

debt markets of 17 industrialized countries during the period 2008–2012.

We use dynamic conditional correlations of sovereign credit default swap

spreads to detect contagion. This approach allows us to separate contagion

channels from the determinants of simple interdependence. The results

show that, first, sovereign credit risk co-moves considerably, particularly

among eurozone countries and during the sovereign debt crisis. Second,

contagion varies across time and countries. Third, similarities in economic

fundamentals, cross-country linkages in banking and common market

sentiment constitute the main channels of contagion.

We would like to thank Mascia Bedendo, Martin Biewen, Claud ia M. Buch, Elena Carlet ti, Elena

Dumitrescu, Carlo Favero, Peter Hansen, Massimil iano Marcellino, Giovanni Piersanti, Esteban Prieto,

Saverio Simonelli and two anonymous referee s for their many helpful comments as well as t he Bank

for International Settlements for ki ndly providing data. The pape r has benefited from comments by

seminar partici pants at the Frankfurt Schoo l of Finance and Management, the EU I and conference

participants at INET 2013, CREDIT 2013, the SUERF/UniCredit and Universities Foundation

Workshop 2013, the IWH/INFER Workshop 2014 and the Annual Conference 2014 of th e German

Economic Association . This research was partly fund ed by the European Regional Developme nt Fund

through the program ‘Investi ng in your Future’. All errors and inaccura cies are our own responsibility.

International Finance 19:3, 2016: pp. 246–268

DOI: 10.1111/infi.12099

© 2016 John Wiley & Sons Ltd

I. Introduction

Divergent sovereign credit risk in Europe ha s received more and more attention in

recent years. While sovereign spreads surge d in countries such as Greece, Ireland,

Portugal, Spain and Italy during 2010–11, they have remained at low levels in

countries such as France and Ger many. Despite this divergence, the eurozone as a

wholeenteredtheglobalfinancial crisis as a hig hly interdependent region wit h

considerable financ ial and trade integrat ion fostered by a common currency. While

such interdepende ncies play an impor tant role in i nternational risk sharing in

normal times, t hey also facilit ate the transmis sion of distress in s overeign debt

markets across nationa l borders in times of crisis. Figure 1 de monstrates that

sovereign credi t risk [a s measured by credit default swap (CDS) spreads] has

followed a common pattern across core and p eriphery eurozone countrie s for the

period 2008–12.

Thus, our interest is not in the reasons for sovereign credit risk diver gence but in

the co-movements of credit risk in i ntegrated markets like the eurozon e. We ask two

0 500 1000 1500

CDS premia (basis points)

01jan2008 01jul2009 01jan2011 01jul2012

Year

France Germany

Ireland Italy

Portugal Spain

Selected countries

0 10000 20000 30000 40000

Greece

0 500 1000 1500

CDS premia (basis points)

01jan2008 01jul2009 01jan2011 01jul2012

Year

Ireland Italy

Portugal Spain

Greece

Periphery eurozone

0 100 200 300 400

CDS premia (basis points)

01jan2008 01jul2009 01jan2011 01jul2012

Year

Austria Belgium

Finland France

Germany Netherlands

Core eurozone

0 50 100 150 200

CDS premia (basis points)

01jan2008 01jul2009 01jan2011 01jul2012

Year

Denmark Japan

Norway Sweden

United Kingdom United States

Non−eurozone

a

cd

b

Figure 1: Credit risk in sovereign debt m arkets

Notes: These graphs plot sovereign CDS premia i n basis points from January 2008 to Sep tem-

ber 2012. The serie s for selected eurozone countries are de picted in the first panel. T he series

for periphery eurozone countrie s are shown in the second panel. The thi rd panel refers to core

eurozone countries and the fina l panel to non-eurozone countries .

Source: Datastream.

Sovereign Credit Risk Co-Movements in the Eurozone 247

© 2016 John Wiley & Sons Ltd