Volatility and mean spillovers between sovereign and banking sector CDS markets: a note on the European sovereign debt crisis

Abstract

This article empirically assesses causality-in-variance and causality-in-mean between the Eurozone banking sector Credit Default Swap (CDS) index and the Greek sovereign CDS spread. We employ the Cross-Correlation Function (CCF) approach developed by Hong (2001) to daily data from January 2008 to December 2011. Our key findings are twofold. First, before the European sovereign debt crisis, significant unidirectional causality-in-variance and causality-in-mean were found from the bank CDS to the Greek sovereign CDS spreads. Second, during the crisis period, we detected significant causality-in-variance from the Greek sovereign CDS spreads to the bank CDS, implying that the deteriorated Greek sovereign solvency might have triggered contagion effects on the banking sector in the area. Our results are relevant for policymakers who provide regulations for the CDS markets.