Conditional sovereign CDS in market basket risk scenario: A dynamic vine-copula analysis

Abstract

This study examines the sensitivity of sovereign CDS markets in G7 and BRICS, which is conditional on a joint market basket risk scenario consisting of crude oil, gold, stock indices, exchange rates, freight indices, and copper prices. By compare the conditional and unconditional sovereign CDS returns using dynamic Vine-Copula model, we find that: 1) The conditional sovereign CDS returns will be less than (greater than) the unconditional ones, when scenario settings is at upper (lower) quantile level. Extreme scenario risk level settings (e.g., 1% or 99%) do not always make a significant difference between conditional and unconditional sovereign CDS. 2) Major black swan evens have significant impact on the difference between the conditional and unconditional sovereign CDS, but such an impact is short-lived especially in G7 countries. 3) Taking into account of the covariate effects, the conditional risk scenarios of sovereign CDS are heterogeneous across countries, down- and up-ward tail as well risk factors associated with the market basket.