Open AccessNetwork Risk in the European Sovereign CDS Market
Author(s) -
Zornitsa Todorova,
Barclays Investment Ban
Publication year - 2020
Publication title -
the review of finance and banking
Language(s) - English
Resource type - Journals
eISSN - 2067-2713
pISSN - 2067-3825
DOI - 10.24818/rfb.20.12.02.03
Subject(s) - credit risk , sovereignty , function (biology) , economics , econometrics , financial economics , business , actuarial science , evolutionary biology , politics , political science , law , biology
This paper applies novel tools from spatial econometrics to measure, quantifyand predict sovereign CDS spreads. Network risk is modelled by making each sovereignísCDS spread a function of the CDS spreads of its ìneighborsî in the Önancial network. Themain Öndings of the paper are: (1) the network model improves forecasting accuracy by 15% to 20%; (2) exogenous Önancial shocks propagate in the network of sovereigns and 40 %to 50% of the total e§ect is due to indirect (network) e§ects. These Öndings suggest analternative explanation to the well-known credit spread puzzle. To rationalize the Öndingsthe paper develops a simple structural network model of sovereign credit risk with Önancialcross-holdings and multiple equilibria.