The Anatomy of Sovereign Credit Contagion

Abstract

We analyze the channels for the cross-border propagation of sovereign credit risk in the international sovereign debt market. We study sovereign credit contagion through the immediate effects of credit events as defined by CDS spread jumps on the credit spreads of other regional sovereigns and on the rest of the world. We find that such “fast and furious” contagion has been primarily a regional phenomenon, however, a global “slow-burn” spillover of credit events was also in force during the recent European debt crisis. We are able to model the protracted spillover mechanism through the effects of identified sovereign credit events on a global sovereign risk factor and time varying country-specific factor loadings.