Working Paper: NBER ID: w16982
Authors: Andrew Ang; Francis A. Longstaff
Abstract: We study the nature of systemic sovereign credit risk using CDS spreads for the U.S. Treasury, individual U.S. states, and major European countries. Using a multifactor affine framework that allows for both systemic and sovereign-specific credit shocks, we find that there is considerable heterogeneity across U.S. and European issuers in their sensitivity to systemic risk. U.S. and Euro systemic shocks are highly correlated, but there is much less systemic risk among U.S. sovereigns than among European sovereigns. We also find that U.S. and European systemic sovereign risk is strongly related to financial market variables. These results provide strong support for the view that systemic sovereign risk has its roots in financial markets rather than in macroeconomic fundamentals.
Keywords: Systemic Risk; Sovereign Credit Risk; CDS Spreads
JEL Codes: E44; F21; F34; F36; G12; G13; G15; G18
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Systemic risk among US sovereigns (H63) | Systemic credit risk constitutes only about 12% of the total credit risk for US states compared to around 31% for European sovereigns (H74) |
| Systemic sovereign credit risk (F34) | Changes in financial markets have a direct causal impact on sovereign credit risk (F65) |
| S&P 500 increases (G12) | US systemic sovereign risk declines significantly (F34) |
| DAX increases (Y10) | European systemic sovereign credit risk declines (F34) |
| Increased volatility in financial markets (G19) | Decrease in perceived US credit risk (F34) |