Systemwide directional connectedness from Crude Oil to sovereign credit risk

Abstract

This study examines the spillovers from Crude Oil price fluctuations to sovereign credit risk, proxied by CDS spreads for 16 oil exporters and importers belonging to G20. Besides measuring shocks from Crude Oil to sovereign risk, it also examined the system-wide impacts of CDS shocks to understand their magnified impacts within a system. Furthermore, the study finds the channels that have the potential to act as a carrier of shocks from Crude Oil to sovereign risk considering four country-specific and two global factors. Our study deployed Generalized Impulse Response Functions and Generalized Forecast Error Variance Decomposition for being independent of ordering. Additionally, DCC-GARCH has been applied to test the robustness of the results. Our results highlight higher spillovers to oil-exporting countries from Crude Oil when compared to oil importers, irrespective of their development stage. Interestingly, developed countries are severely impacted by net system-wide shocks from developing and oil-exporting countries. Moreover, Global factors play a dominant role in carrying the shocks from Crude Oil to sovereign risk of countries. Stock market indices are important among important domestic factors that act as carriers of shocks, and VIX is robust amongst global variables. Our results are valuable to Regulators, policymakers, portfolio managers, banks, and financial institutions for proactively planning their respective policies.