The Macrotheme Review A multidisciplinary journal of global macro trends

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1 Takayas Io, The Macroheme Revew 4(3), Srng 205 The Macroheme Revew A mldsclnary jornal of global macro rends Analyss of Soveregn CDSs n he PIIGS Conres Co-movemen and Transmsson drng he Erozone Crss Perod Takayas Io Mej Unversy, School of Commerce, Tokyo Jaan Noe Absrac Ths aer analyzes he co-movemen and ransmsson of soveregn cred defal swas (CDSs) n he PIIGS (Porgal, Ialy,, and San) conres drng he erod of he Erozone soveregn crss. Soveregn CDSs among he fve PIIGS conres moved ogeher drng he erod. roelled he soveregn CDS marke of he oher for PIIGGS conres. On he oher hand, no nflence on from oher PIIGS conres was fond. From he emrcal analyss, can be conclded ha he fnancal conagon exsed among soveregn CDS markes of PIIGS conres., whch was n he sae of severe fscal crss, was a drvng force n he fnancal conagon of he Erozone. Keywords: Soveregn CDS, PIIGS Conres, Erozone Crss, Fnancal Conagon.Inrodcon Ths aer focses on he fnancal conagon cased by he soveregn cred defal swas (CDSs) of he PIIGS (Porgal, Ialy,, and San) conres drng he Erozone soveregn crss. Orgnally, he CDS was nrodced o serve as a sor of nsrance nsofar as s a fnancal swa agreemen whereby he seller wll comensae he byer f here s a cred even. The byer of he CDS makes a seres of aymens o he seller and, n exchange, receves a comensaon ayoff f here s a defal, whereon he seller reakes ossesson of he defalng bond or loan. As he Erozone soveregn crss deeened arond he mddle of 200, massve sell-offs were observed, esecally n Greek bonds, whose CDS remm rose dramacally. Ths rggered a rse n governmen bond yelds and CDS remms n oher conres sch as, Ialy, San and Porgal. Ths aer s fnancally sored by a gran-n-ad from he Zengn Fondaon for Sdes on Economcs and Fnance. I also obaned a Gran-n Ad for Scenfc Research (KAKENHI ) from JSPS. The commens made by anonymos revewers are hghly arecaed. 7

2 Takayas Io, The Macroheme Revew 4(3), Srng 205 Ths aer analyzes he co-movemen and ransmsson of soveregn CDSs n he PIIGS conres drng he Erozone soveregn crss. I nvesgaes hs from wo ons of vew. Frsly, looks a he co-movemen of soveregn CDSs n he PIIGGS conres. Secondly, nvesgaes he ransmsson of CDSs among PIIGS conres. The conrbon of hs aer o he lerare s ha nforms s as o wheher he cred crss was shared n hese conres and whch conry was a drvng facor of Erozone soveregn crss, esecally n he fve PIIGS conres. Many of he CDS relaed sdes, sch as Aler and Beyer (204), Berne and Frazscher (203), Calce e al(203), Gorea and Radev(204), Grammakos and Vermelen (202), and Kalbaska and Gakowskb (202), focs on fnancal conagon. Aler and Beyer (204) qanfy sllovers beween soveregn cred markes and banks n he ero area. Sllovers are esmaed recrsvely from he VAR (Vecor Aoregressve) model of daly changes n CDS sreads wh exogenos common facors. Berne and Frazscher (203) analyze he drvers of soveregn rsk for 3 advanced and emergng economes drng he Eroean soveregn deb crss. Ther sdy shows ha deeroraon n fndamenals of conres and shar rse n he sensvy of fnancal markes o fndamenals were he man exlanaons for he rse n soveregn yeld sreads and CDS sreads. The major fndng of Calce e al. s(203) sdy s ha, for several conres, ncldng, and Porgal, he lqdy of he soveregn CDS marke has a sbsanal me varyng nflence on soveregn bond cred sreads. Gorea and Radev (204) examne he deermnans of he jon defal rsk of ero area conres drng 2007 o 20and recover jon defal robables from ndvdal CDS conracs. In conras o earler heorecal sdes, hey fnd ha fnancal lnkages are an acve conagon of ransmsson channel only n he case of he robled erhery ero area economes. Grammakos and Vermelen (202) show ha fnancals became sgnfcanly more deenden on changes n he dfference beween he Greek and German CDS sreads afer Lehman's collase, comared wh he re-lehman sb erod. Kalbaskaa and Gakowsk (202) confrm ha and he oher PIIGS conres (even San and Ialy) had a lower caacy o rgger conagon han core EU conres. In addon, Porgal was he mos vlnerable conry, whereas he UK was he mos mmne o shocks. The remander of hs aer s organzed as follows: Secon 2 descrbes he daa and rovdes smmary sascs; Secon 3 dscsses he mehodology; Secon 4 resens he resls; and Secon 5 concldes he aer. 2. Daa The CDS marke s lqd only n he mary of fve years. The daa of he CDSs wh a mary of fve years are sed n hs analyss. The samle erod rns from Janary 29, 2009 o Seember 6, 20. The fve PIIGS (Porgal, Ialy,, and San) conres are chosen for hs sdy. Daa are rovded by Bloomberg on a daly bass. CDS s qoed by bass on and ercenage n he marke. The movemen of CDSs s shown n Fgres. The descrve sascs of he daase are shown n Table. 8

3 2009// /3/ /5/ /7/ /9/ //29 200//29 200/3/29 200/5/29 200/7/29 200/9/29 200//29 20//29 20/3/29 20/5/29 20/7/29 Takayas Io, The Macroheme Revew 4(3), Srng 205 b 6,000 5,000 4,000 3,000 2,000,000 Porgal Ialy San 0 Fgre Movemen of CDS Noes : CDS rces of PIIGS (Porgal,, Ialy,, and San) are shown. The samle erod s from Janary 29, 2009 o Seember 6, 20. The daa sorce s Bloomberg. Table Descrve sascs Varable Average SD Mn Max Medan Porgal Ialy San Noe: The samle erod s from Janary 29, 2009 Seember 6, 20. Abo wo weeks before he samle erod began, on Janary 4, Sandard and Poor s (S&P) downgraded he rang of Greek governmen bonds o A on he bass ha he conry s fscal defc wold worsen whn he downward rend of he global economy. Moody s Invesors Servce also downgraded 's local- and foregn-crrency bond rangs o Ca from Caa on Jly 25, 20, abo wo monhs before he end of he samle erod. 9

4 Takayas Io, The Macroheme Revew 4(3), Srng 205 Accordng o Moody s Invesor Servce (203), oblgaons raed Ca are hghly seclave and are lkely o be n defal or very close o, wh some rosec of recoverng he rncal and neres. Alhogh he Inernaonal Swas and Dervaves Assocaon (ISDA) annonced ha he Greek case was no a cred even on Ocober 3, 20, he las day when rce nformaon of CDS rce nformaon was daed on he nformaon vendor was Seember 6, Mehodology 3.. Un Roo Tes Becase emrcal analyses of he erod from he md-980 s o he md-990 s show ha daa sch as neres raes, foregn exchange and socks are non-saonary, s frsly necessary o check wheher he daa sed n hs aer conan n roos. ADF (Agmened Dckey/Fller) and PP (Phlls/Perron) ess are condced. Boh he ADF and PP ess defne he nll hyohess as n roos exs and he alernave hyohess as n roos do no exs. Fller (976) rovdes he ables for he ADF and PP ess. Frsly, he orgnal daa are checked o see wheher hey conan a n roo. Then, he daa wh frs dfferences are analyzed o see wheher hey have a n roo n order o confrm ha he daa reresen I () varables. 3.2 Conegraon Tes Generally seakng, he ordnary leas sqares (OLS) mehod s sed o analyze he relaonshs among varables. However when non-saonary varables are nclded, ordnary hyohess esng ends o rodce erroneos resls becase he coeffcen of deermnaon and -sascs do no follow a smle dsrbon. Granger and Newbold (974) call hs roblem sros regresson. Phlls (986) ons o wo hngs abo he analyss of non-saonary daa: () he coeffcen of deermnaon ends no o measre he relaonshs among varables, and (2) he esmaed eqaon wh a low Drbn- Wason rao can be sbjec o he roblem of sros regresson. A non-saonary me seres model s necessary o coe wh hese roblems. There are wo man yes of conegraon es; () Johansen (988), (2) Engle and Granger (987). The mos dffcl ar of a conegraon analyss sarng from a VAR model s decdng on he nmber of conegraon relaonshs. For examle, when hree varables are analyzed, he nmber of conegraon relaonshs may be one or wo. The mehod roosed by Engle and Granger canno coe wh hs roblem, b Johansen s aroach does rovde a means o decde he nmber of conegraon relaonshs 2. In hs aer, he conegraon analyss s aled as descrbed below o nvesgae he comovemen of dsress afer s confrmed ha he daa are non-saonary I () varables. Johansen sggess an analyss sng he k order VAR model. Here, he VAR model s resened wh k order agans vecor X wh varables. See Dckey and Fller (979), Dckey and Fller (98), and Phlls and Perron (988). 2 For more deals, see Engle and Granger (987) and Johansen (988). 20

5 Takayas Io, The Macroheme Revew 4(3), Srng k k X X X () All he elemens of X are consdered o be I () varables. s an error erm wh zero mean and λ s a consan erm. The Johansen conegraon es s aled o he CDSs n he PIIGS conres. Maxmal egen vale and race ess are condced o nvesgae he conegraon relaonsh. When sch conegraon relaonsh s fond, may be conclded ha he CDS markes n he PIIGS conres move n he long-rn eqlbrm. In oher words, he CDSs n PIIGGS conres co- move. 3.3 Granger Casaly Tes Granger casaly ess are aled o nvesgae he casales among CDS rces n he fve saed conres and hence o denfy he ransmsson of conagon. The orgnal daa are sally ransformed no he change rao o avod he roblem of sros regresson, b sng hese daa s consdered o case an error. Toda and Yamamoo (995) develoed he Granger casaly es n whch non-saonary daa are sed drecly. Accordng o her mehod, he nll hyohess s esed by addng rend erm and + (orgnal lag ls one) for he esmaon of he for eqaons menoned below. As olned below, hese for eqaons are sed o es he CDSs n he PIIGS conres: for examle, eqaon (3) checks f he CDS of Ialy,,, San and Porgal Granger-case he CDSs of Porgal. The Schwarz's Bayesan nformaon creron (BIC) sandard s sed for he orgnal nmber of lags. (3) 0 Porgal San Ialy Porgal (4) 0 Porgal San Ialy Ialy (5) 0 Porgal San Ialy y (6) 0 Porgal San Ialy (7) 0 Porgal San Ialy San 4.Resls 4. Un Roo Tes Frsly, ADF and PP ess are condced for he orgnal seres boh wh and who me rends. The resls are shown n Tables 2 and 3.The BIC sandard s sed for he deermnaon of lag lengh n he ADF es. The crcal on of 5% for he ye of T = s 2.86(who rend) and 3.4(wh rend) as reored n Fller (976). I s aaren ha all he varables are nonsaonary.

6 Takayas Io, The Macroheme Revew 4(3), Srng 205 Table 2 ADF es - orgnal seres Varable Who Trend Wh Trend Porgal Ialy San Noes: * ndcaes sgnfcance a 5 % level. 5% crcal vales are 2.88 (who rend), 3.43 (wh rend). Table 3 PP es - orgnal seres Varable Who Trend Wh Trend Porgal Ialy San Noes: * ndcaes sgnfcance a 5 % level. 5% crcal vales are 2.88 (who rend), 3.43 (wh rend). Nex, he daa wh frs dfference from he orgnal daa are analyzed sng he ADF and PP ess. These resls are shown n Tables 4 and 5. I s ossble o conclde ha all he varables are I (). Table 4 ADF es - frs dfferenced seres Varable Who Trend Wh Trend Porgal -.588* -.849* -8.27* * Ialy * * * -.5* San -8.35* -8.47* Noes: * ndcaes sgnfcance a 5 % level. 5% crcal vales are 2.88 (who rend), 3.43 (wh rend). 22

7 Takayas Io, The Macroheme Revew 4(3), Srng 205 Table 5 PP es - frs dfferenced seres 4.2 Johansen Conegraon Tes The Johansen conegraon es s condced for fve varables. The resls are shown n Table 6. Two conegraon relaonshs are fond sng he maxmal egenvale es and one s fond sng he race es. Ths s roer o jdge ha one conegraon relaonsh exss among he soveregn CDSs of he fve PIIGS conres. These soveregn CDSs are consdered o shf drng he long- erm eqlbrm drng he erod of Erozone crss. In oher words, soveregn CDS among he fve PIIGS conres moved ogeher n he erod from Janary 29, 2009 o Seember 6, Granger Casaly Tes Varable Who Trend Wh Trend Porgal -.588* -.849* -8.27* * Ialy * * * -.5* San -8.35* -8.47* Noes: * ndcaes sgnfcance a 5 % level. 5% crcal vales are 2.88 (who rend), 3.43 (wh rend). The Granger casaly ess develoed by Toda and Yamamoo (995) are condced. The resls are shown n Table 7. Casales from o he oher for conres (Porgal,, Ialy, and San) are fond, b no he oher way. Casales from Porgal o, Ialy, and San are fond, as are casales from o San, from Ialy o Porgal, and from San o Ialy. Table 6 Johansen conegraon es Nll Alernave Tes Sascs 5% Crcal Vale Tes Sascs 5% Crcal Vale Maxmal Egenvale Tes Trace Tes r = 0 r = * * r r = * r 2 r = r 3 r = r 4 r = Noes: * ndcaes sgnfcance a 5 % level. Crcal vales are from Oserwald-Lenm (992). 23

8 Takayas Io, The Macroheme Revew 4(3), Srng 205 Table 7 Granger casaly es Varables Tes Sascs Varables Tes Sascs Porgal 2.58* Porgal.649 Porgal Ialy 2.259* Porgal San 2.864* Porgal Ialy.349 San 3.750* Ialy Porgal 4.029* Ialy.763 Ialy.437 Ialy San 2.67 Porgal 2.840* 2.847* Ialy 4.627* San 3.8* San Porgal San San Ialy 3.075* San.283 Noes: *,** ndcaes sgnfcance a 5 % level and 0 % level. As for he nmber of lags, one s added o BIC selecon. 5. Conclson Ths aer analyzes he co-movemen and ransmsson of soveregn CDSs n he PIIGS conres drng he Erozone soveregn crss. I nvesgaes hs from wo ons of vew for he erod from Janary 29, 2009 o Seember 6, 20. Frsly, looks a he co-movemen of soveregn CDSs n PIGGS conres. Secondly, nvesgaes he ransmsson of CDSs among PIIGS conres. Ths makes s o know wheher cred crss was shared n hese conres and whch conry was a drvng facor of he soveregn crss of Erozone, esecally n he PIIGS conres. Soveregn CDSs among he fve PIIGS conres moved ogeher drng he erod of he Erozone soveregn crss. roelled he soveregn CDS marke. On he oher hand, no nflence on from he oher PIIGS conres was fond. From he emrcal analyss, can be conclded ha fnancal conagon exsed among he soveregn CDS markes of he PIIGS conres., whch was n a sae of severe fscal crss, was a drvng force n he fnancal conagon of he Erozone. References Aler, A. and Beyer, A. (204). The dynamcs of sllover effecs drng he Eroean soveregn deb rmol. Jornal of Bankng and Fnance, 42(5), Berne, J. and Frazscher, M.(204). The rcng of soveregn rsk and conagon drng he Eroean soveregn deb crss. Jornal of Inernaonal Money and Fnance, 34,

9 Takayas Io, The Macroheme Revew 4(3), Srng 205 Calce, G. e al (203).Lqdy sllovers n soveregn bond and CDS markes: An analyss of he Erozone soveregn deb crss. Jornal of Economc Behavor & Organzaon, 85, Dckey, D.A. and Fller,W.A. (979). Dsrbon of he esmaors for aoregressve me seres wh a n roo. Jornal of he Amercan Sascal Assocaon, 74(366), Dckey, D.A. and Fller,W.A. (98). Lkelhood rao sascs for aoregressve me seres wh a n roo. Economerca, 49(4), Engle, R.F. and Granger,C.W.J. (987). Co-negraon and error correcon: Reresenaon, esmaon, and esng, Economerca, 55(2), Fller,W.A. (976). Inrodcon o sascal me seres. John Wley & Sons,Inc. Gorea, D. and Radev, D.(204). The ero area soveregn deb crss: Can conagon sread from he erhery o he core? Inernaonal Revew of Economcs & Fnance, 32(2), Grammakos, T. and Vermelen, R. (202). Transmsson of he fnancal and soveregn deb crses o he EMU: Sock rces, CDS sreads and exchange raes. Jornal of Inernaonal Money and Fnance,3(3), Johansen, S. (988). Sascal analyss of conegraed vecors. Jornal of Economc Dynamcs and Conrol, 2 (2-3), Kalbaska, A. and Gakowsk, M.(202). Erozone soveregn conagon: Evdence from he CDS marke ( ). Jornal of Economc Behavor & Organzaon, 83(3), Moody s Invesor Servce, (203). Rang symbols and defnons. Oserwald-Lenm,M., (992). Praconers corner: A noe wh qanles of he asymoc dsrbon of he maxmm lkelhood conegraon rank es sascs. Oxford Bllen of Economcs and Sascs, 54, Phlls, P.C.B. (986). Undersandng sros regressons n economercs, Jornal of Economercs, 33(3), Toda, H.Y. and Yamamoo, T. (995). Sascal nference n vecor aoregressons wh ossbly negraed rocesses. Jornal of Economercs, 66(-2),