Credit Risk Spillovers Research Articles

Multiscale Cross-sector Tail Credit Risk Spillovers in China: Evidence from EEMD-based VAR Quantile Analysis

This paper employs EEMD-based VAR for VaR methodology to explore the spillovers of credit risk across sectors in China, focusing on multiple time scales and tail effects. Analysis of daily sectoral CDS spreads reveals that the extent and direction of cross-sector tail risk spillovers vary across sectors and time horizons, showing more pronounced effects in the medium to long term. Notably, the most substantial upside tail credit risk spillovers have been found from the Government sector to others. Moreover, asymmetric spillovers are verified at all time scales, and the extent of these spillovers varies depending on the conditioning quantiles. Finally, the results of the multiscale pseudo quantile impulse response analysis show that sectoral tail credit risk is more sensitive to negative shocks from other sectors than to positive ones, with responses decaying at a slower rate for negative shocks. These findings provide valuable insights for investors and regulators.

Dynamic credit risk transmissions among global major industries: Evidence from the TVP-VAR spillover approach

We examine the dynamics of credit risk connectedness by analyzing credit default spreads in four major sectors (banks, transportation, manufacturing, electricity) across three global regions (Asia, Europe, North America) using the TVP-VAR spillover methodology from 2007 to 2024. We have identified significant findings regarding credit risk spillovers among them. First, there are consistently high levels of credit risk spillovers between sectors, indicating underlying economic factors influencing the transmission of credit risk shocks. Second, notable regional findings include a substantial increase in credit risk connectedness for Asian banks during the global financial crisis (GFC). European manufacturing sectors also displayed significantly high connectedness levels during both the GFC and the COVID-19, while North American banks saw a notable surge due to the collapse of Silicon Valley Banks (SVB) in March 2023. In addition, during the RU-war, the electricity and manufacturing sectors in Europe had high CDS connectedness. Lastly, a distinct observation emerged concerning the Asian transportation sector. These findings have practical implications for policymakers and portfolio managers. For instance, they can help policymakers assess the effectiveness of their policies by revealing global industry credit risk interconnections. Additionally, the dynamic credit risk linkages provide strategies for hedging credit risk.

The role of climate change in sovereign credit risk spillovers? Evidence from G20 countries

This study investigates sovereign credit risk spillovers in G20 countries, emphasizing the impact of climate policy uncertainty using DY spillover index framework and GARCH-MIDAS model. Empirical results show Mexico, Brazil and South Africa as primary transmitters, with the G7 countries as net receivers. We find an inverse relationship between climate uncertainty and sovereign CDS spillovers, particularly affecting highly integrated G20 countries. These results highlight the need to incorporate climate policy into risk management.

Spillover among Sovereign Credit Risk and the Role of Climate Uncertainty

This study investigates sovereign credit risk spillovers in G20 nations, emphasizing the impact of global climate policy uncertainty. This study analyzes the dynamics of these spillovers using sovereign credit default swap (SCDS) spreads and the time-varying parameter vector autoregressive approach. The study finds that Indonesia and Mexico are key risk transmitters within the G20. Linear and quantile regressions show an inverse relationship between climate uncertainty and SCDS spillovers, particularly affecting highly integrated G20 countries. These results highlight the need for coordinated and transparent climate policies to ensure financial stability among G20 nations.

European bank credit risk transmission during the credit Suisse collapse

The effect of Credit Suisse collapse on the credit risk spillover across banks is understudied and unclear. Using the tail-event and network dynamics framework on weekly data covering 15 large European banks from March 11, 2020 to March 28, 2023, we show that the credit risk has a strong spillover effect on major banks, increasing systemic risk significantly after the collapse of Credit Suisse. This is notable for non-EU (Swiss and UK) banks in the post-collapse era. The findings are useful for policymakers and regulators concerned with contagious credit risk and the stability of the banking sector under extreme events.

What is mine is yours: Sovereign risk transmission during the European debt crisis

We develop an empirical network model to characterize the density of bilateral sovereign credit risk spillovers during the European debt crisis. We show that the spillover density is often asymmetric with heavy tails and that its location and shape vary strongly and systematically in relation to published indicators of systemic stress. Using auxiliary panel data models, we show that the intensity of bilateral spillovers is related to the portfolio investment exposures among country pairs. Because our spillover statistics can be updated daily, they represent a valuable supplement to existing weekly and monthly measures of systemic stress.

Quantile Connectedness: Modeling Tail Behavior in the Topology of Financial Networks

We develop a new technique to estimate vector autoregressions with a common factor error structure by quantile regression. We apply our technique to study credit risk spillovers among a group of 17 sovereigns and their respective financial sectors between January 2006 and December 2017. We show that idiosyncratic credit risk shocks propagate much more strongly in both tails than at the conditional mean or median. Furthermore, we develop a measure of the relative spillover intensity in the right and left tails of the conditional distribution that provides a timely aggregate measure of systemic financial fragility and that can be used for risk management and monitoring purposes. This paper was accepted by Gustavo Manso, finance.

Banks’ international assets and sovereign default risk

PurposeThis paper aims to investigate the nexus between banks’ foreign assets and sovereign default risk in a panel of 15 developed economies. The empirical evidence suggests that banks’ foreign exposure is an important determinant of sovereign default probability.Design/methodology/approachUsing data from the consolidated banking statistics (total foreign claims on ultimate risk basis) by the Bank of International Settlements, the author constructs a measure of bank international exposure to peer countries. This measure is then used as the target variable in a panel regression for sovereign credit default swaps. The model includes 15 European and non-European developed economies. Identification is discussed extensively in the paper.FindingsQuantitatively, a 1% increase in banks’ cross-border claims increases sovereign default risk by about 0.19%. The relationship is weaker when banks are more capitalised. On the other hand, governments are more vulnerable to credit risk spillovers from banks’ international portfolios when having higher debt to GDP ratios.Originality/valueTo the best of the author’s knowledge, this is the first paper that attempts explicitly to establish an empirical connection between banks’ international assets and sovereign default risk. To the author’s opinion, this paper represents a contribution to our understanding of how sovereign credit risk spills over across countries. It also extends significantly the existing literature on the determinants of sovereign risk (that primarily focused on fundamentals, market characteristics – such as liquidity – and global factors). This paper ultimately sheds some new light on the role of intermediaries in the international transmission of credit risk, also adding to today’s discussion about the linkages between banks and sovereigns.

Credit risk spillovers and cash holdings

This paper examines how credit risk spillovers affect corporate financial flexibility. We construct separate empirical proxies to disentangle the two channels of credit risk spillovers—credit risk contagion (CRC), where one firm's default increases the distress likelihood of another; and product market rivalry (PMR), where the same default strengthens the position of a competitor. We show that firms facing greater CRC have weaker subsequent operating performance and must contend with less favorable bank loan terms. Meanwhile, they accumulate more cash by issuing equity, selling assets, and reducing investment and payout. In contrast, PMR generally has opposite, albeit weaker, effects. Our findings suggest that credit risk spillovers, especially CRC, play an important role in corporate liquidity management.

Credit Contagion and Risk Sharing among State Governments

We investigate how the negative credit events of a state can affect the credit risk of other states as well as the channels of state credit-risk spillover in the U.S. We find that one state’s credit rating downgrades and credit default swap jumps have a contagion effect on the credit risk of other states. In contrast, a negative credit outlook can introduce credit competition to non-event states. Additionally, risk sharing via capital markets and federal government are two crucial channels on the spillover effects. Industry similarity, political connections, and geographical proximity could affect the size of the interstate spillovers. Key words: State credit events, risk sharing, capital market, credit market, federal government

The value of bond underwriter relationships

We show that corporate bond issuers benefit from utilizing existing underwriter relationships when rolling over bonds, but at the same time become exposed to underwriter distress. A strong relationship enables the underwriter to credibly certify the issuer resulting in lower direct issuance costs and lower underpricing. However, if the underwriter becomes distressed, this spills over to the issuer's credit risk, because it weakens the relationship and increases the risk of involuntary relationship termination. The credit risk spillover is more pronounced for risky, information-sensitive issuers with high rollover exposure, i.e., those issuers most in need of certification by an underwriter.

Bad or good neighbours: a spatial financial contagion study

PurposeThe purpose of this paper is to study the evolution of financial contagion between Eurozone banks, observing the credit default swaps (CDSs) market during the period 2009–2017.Design/methodology/approachThe authors use a dynamic spatial Durbin model that enables to explore the direct and indirect effects over the short and long run and the transmission channels of the contagion.FindingsThe results show how contagion emerges through physical and financial market links between banks. This finding implies that a bank can fail because people expect other related financial institutions to fail as well (self-fulfilling crisis). The study provides statistically significant evidence of the presence of credit risk spillovers in CDS markets. The findings show that equity market dynamics of “neighbouring” banks are important factors in risk transmission.Originality/valueThe research provides a new contribution to the analysis of EZ banking risk contagion, studying CDS spread determinants both under a temporal and spatial dimension. Considering the cross-dependence of credit spreads, the study allowed to verify the non-linearity between the probability of default of a debtor and the observed credit spreads (credit spread puzzle). The authors provide information on the transmission mechanism of contagion and, on the effects among the largest banks. In fact, through the study of short- and long-term impacts, direct and indirect, the paper classify banks of systemic importance according to their effect on the financial system.

Digital economy era: the role of the telecommunications sector in frequency-dependent default risk connectedness

We use frequency-dependent connectedness measures to study the role played by the telecommunications (telecoms) sector in sectoral default risk connectedness at three frequency bands, i.e. the short-, medium-, and long-term financial cycles. We extend credit risk spillovers analysis from the time domain to the frequency domain. Our findings indicate that investors in the global CDS sector index market have different investment horizons, but they prefer to process default risk information mainly within one week. In the within-region analysis, except for North America, the telecoms sector plays a significant role in transmitting net credit risk to the other sectors, especially in the short-term financial cycle. In the cross-region analysis, the European telecoms sector is the major net default risk transmitter on all three frequency bands. Our study has noteworthy empirical implications for consumption-based asset pricing models, cross-sector credit risk connectivity, and regional financial stability.

Dependence structures and risk spillover in China’s credit bond market: A copula and CoVaR approach

This study uses a dynamic copula model of dependence to investigate risk spillovers in China’s credit bond market between the bank and corporate sectors for a range of maturities from one week to 30 years. Using daily data on credit spreads for the period December 28, 2009 to June 2, 2017, the empirical results show that credit risk spillover is low and relatively stable for medium-term bonds, but higher and more variable for short- and long-term bonds. The results also show that credit risk spillover increased after 2014 with financial market reforms that involved interest rate liberalization and a loosening of government guarantees on corporate debt.

International risk spillover in sovereign credit markets: an empirical analysis

PurposeThe purpose of this paper is to study the volatility spillover among 33 worldwide sovereign Credit Default Swap (CDS) markets and their underlying bond markets.Design/methodology/approachIn contrast to prior studies, the authors incorporate heteroscedasticity, asymmetric leverage effects and long-memory features of sovereign credit spreads simultaneously through a bivariate FIEGARCH model and a Bayesian cointegrated vector autoregressive model.FindingsSimilar to the literature, the findings confirm that strong evidence of credit risk spillover between credit markets is accentuated during two recent crisis periods. However, the country-by-country analysis indicates that countries exhibit different sensitivity levels and divergent reactions to financial shocks. Further, the authors show that the bidirectional interrelationship evolves over time and across countries emphasizing the necessity of time-varying national regulatory policies and trading positions.Originality/valueBased on a large data set that covers the recent two financial crises and using complex methods, the work focuses on sovereign tensions that have repercussions on banks’ solvency and refinancing conditions. Yet, the study is a hot topic since that during crisis periods in the financial markets, direct and indirect interconnections increase between sovereign risk and banking risk. Using new econometric approaches, the results show that each country exhibits a different behavior toward the credit risk which is relevant to both portfolio managers and policy makers. The time-varying spillover effects detected between markets are an accurate indicator of financial stability, allowing policy makers to put in place personalized economic policies. On the other hand, markets’ participants could take advantages of the results by adjusting their trading and hedging positions on the dynamic co-movements. The findings reveal, as well, that the sovereign crisis has more weakened the global financial and banking system than the subprime crisis. The authors previously tackled the cross-country contagion phenomenon in the CDS markets, and this manuscript builds on the prior study to enhance the obtained results.

Associated Credit Risk Contagion and Spillover Effect Based on Supply Chain Buy-Back Guarantee Contract

We take the supply chain with a supplier and a retailer as the research objects and study the contagion and spillover effect of the associated credit risk in the supply chain under the scenario of the buy-back guarantee contract. The associated credit risk in the supply chain refers to the phenomenon that the credit default of the retailer causes the credit default of the supplier or increases the probability of default. The buy-back guarantee in the supply chain refers to the assumption by the retailer of the supplier’s buy-back contract as a financing mechanism. At present, the buy-back guarantee has become a new channel of contagion for the associated credit risk in the supply chain. Under the dual Stackelberg game analysis framework of the lending institutions, suppliers, and retailers, this paper clarifies the contagion mechanism of associated credit risk in the supply chain under the condition of the buy-back guarantee and constructs mathematical models to explore the contagion and spillover effect of the associated credit risk in the supply chain. The results show that, under the condition of the buy-back guarantee, the contagion effect of the associated credit risk in the supply chain has trigger thresholds, and the probability of triggering the contagion effect is related to the retailer’s order quantity, supplier’s wholesale price, and product’s market price. The contagion effect is positively affected by the buy-back rate, production costs, and loan interest rates and negatively affected by the product’s market price. In contrast, the degree of buy-back guarantee aggravates the negative spillover effect of the associated credit risk and raises the risk level of lending institutions.

Financial sector bailouts, sovereign bailouts, and the transfer of credit risk

We develop an empirical network model to study credit risk spillovers among a group of eighteen sovereigns and their financial sectors from 2006 to 2015. Initially a net source of credit risk, the financial sector becomes a net recipient after the 2008 financial sector bailouts in many countries. Fiscal fundamentals explain much of the heterogeneity in financial-sovereign spillovers over this period. The subsequent European sovereign bailouts disrupt the feedback between sovereign risk and local financial sector risk. Depending on the initial fiscal position of the target country, sovereign bailouts may also disrupt international credit risk spillovers originating from the target sovereign.

Monetary Policy, Bank Bailouts and the Sovereign-Bank Risk Nexus in the Euro Area*

Abstract The article analyses the empirical relationship between bank credit risk and sovereign credit risk in the euro area, using a system of simultaneous equations identified through heteroskedasticity. We first confirm a two-way causality between both risks, which amplifies initial credit risk shocks. We also document significant credit risk spillovers between sovereigns and banks in the periphery and the core countries. The article then focuses on the impact of ECB non-standard monetary policy and bank bailout policies. We show that bailouts have reduced both risks. Monetary policy lowered in most but not all cases bank and sovereign risk.

Quantile Connectedness: Modelling Tail Behaviour in the Topology of Financial Networks

We develop a new technique to estimate vector autoregressions by quantile regression. A factor structure is used to remove cross-section correlation in the residuals such that the system can be estimated on an equation-by-equation basis using existing quantile regression toolboxes. We use our model to study credit risk spillovers among a panel of 18 sovereigns and their respective financial sectors between January 2006 and February 2012. We show that idiosyncratic credit risk shocks do not propagate strongly at the median but that powerful spillovers occur in both tails. Furthermore, rolling sample analysis reveals marked time-varying tail-dependence. These important features of credit risk transmission are obscured in models estimated using conventional conditional mean estimators.

Credit Risk Spillovers and Financial Flexibility

This paper examines how credit risk spillovers affect corporate financial flexibility. We construct separate empirical proxies to disentangle the two channels of credit risk spillovers—credit risk contagion (CRC), where one firm's default increases the distress likelihood of another; and product market rivalry (PMR), where the same default strengthens the position of a competitor. We show that firms facing greater CRC have weaker subsequent operating performance and must contend with less favorable bank loan terms. Meanwhile, they accumulate more cash by issuing equity, selling assets, and reducing investment and payout. In contrast, PMR generally has opposite, albeit weaker, effects. Our findings suggest that credit risk spillovers, especially CRC, play an important role in corporate liquidity management.