Dependence Structures between Sovereign Credit Default Swaps and Global Risk Factors in BRICS Countries

Prayer M. Rikhotso,Beatrice D. Simo-Kengne

doi:10.3390/jrfm15030109

Prayer M. Rikhotso, Beatrice D. Simo-Kengne

Open Access

https://doi.org/10.3390/jrfm15030109

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Abstract

This study investigates the tail dependence structures of sovereign credit default swaps (CDSs) and three global risk factors in BRICS countries using a copula approach, which is popular for capturing the “true” tail dependence based on the “distribution-adjusted” joint marginals. The empirical results show that global market risk sentiment comoves with sovereign CDS spreads across BRICS countries under extreme market events such as the pandemic-induced crash of 2020, with Brazil reporting the highest bilateral convergence followed by China, Russia, and South Africa. Furthermore, oil price volatility is the second biggest risk factor correlated with CDS spreads for Brazil and South Africa, while exchange rate risk exhibits very low co-dependence with CDS spreads during extreme market downturns. On the contrary, exchange rate risk is the second largest risk factor co-moving with China and Russia’s CDS spreads, while oil price volatility exhibits the lowest co-dependence with CDS in these countries. Between oil price and currency risk, evidence of single risk factor dominance is found for Russia, where exchange rate risk is largely dominant, and policymakers could promulgate financial sector regulations that mitigate spill-over risks such as targeted capital controls when markets are distressed.

Highlights

BRICS economies enjoyed a significant rise in foreign investment inflows in the last 20 years as global investors diversify away risk and pursue investments with higher yields, resulting in net portfolio inflows peaking at USD 55.5bn in 2019, up fromUSD 12.3bn in 2009 (World Bank 2021)
This study examined the tail dependence structure of sovereign credit risk and each of three selected global risk factors for the BRICS community using the copulas approach, which is known for its ability to provide the “true” tail correlation based on the correct marginal distribution
The empirical results show that global market risk sentiment is very crucial in driving sovereign credit default swaps (CDSs) spreads in the BRICS countries under extreme market events, with Brazil having the highest co-dependency, followed by China, Russia, and South Africa

Summary

Introduction

BRICS economies enjoyed a significant rise (i.e., quadrupled) in foreign investment inflows in the last 20 years as global investors diversify away risk and pursue investments with higher yields, resulting in net portfolio inflows peaking at USD 55.5bn in 2019, up from. A recent study on BRICS investigated the dependence structure of sovereign CDS and oil price volatility in BRICS and G7 countries using copula with wavelet analysis and found evidence of simultaneous co-movements during economic prosperity, but divergence was evident during macroeconomic downturns (Yang et al 2018). They used copulas to investigate the intensity of association, which focused on the association of sovereign CDS spreads and exchange rate and/or oil price risk and reported the existence of empirical relationships across developed and emerging markets’ sovereign CDSs (Caillault and Guegan 2005; Wang et al 2020).

Empirical Literature Review

Data Scoping, Collection Frequency, and Transformations

Visual Inspection of Daily Volatilities and Changes in CDS and Global Risks

Macroeconomic

Volatility

The Optimal Copula

Optimal Copulas Using VineCopula Package

Pairwise Tail-Dependence of Sovereign CDS and Global Risks

Exploratory Analysis of Daily Returns Structure

Linear Dependence Structures—Simple Linear Correlation Measure

Pairwise Tail Dependence of Risk Factors and Sovereign CDS

Comparison of Tail Dependence Structures within and across BRICS Countries