Ge, S.

A Revisit to Sovereign Risk Contagion in Eurozone with Mutual Exciting Regime-Switching Model

CWPE20114

Abstract: This paper proposes a new mutual exciting regime-switching model where crises can spread contagiously across countries. Each country has its own hidden stochastic process that determines whether the country is in a normal or crisis regime. Contagion is defined as a rise in the transition probability to the crisis regime when other countries are in crisis in the past state. Using this new approach, I revisit the sovereign risk contagion in the euro area. I find that there are striking shifts in market pricing functions for the sovereign bond spreads. Multi-country contagion plays a dominant role in driving such shifts, while common risk factors and country-specific fundamentals are much less important.

Keywords: Contagion, Inter-dependence, Regime-switching, Mutual excitation, Sovereign credit risk

JEL Codes: C10 C58 F36 G12 G15

Author links:

PDF: https://www.econ.cam.ac.uk/research-files/repec/cam/pdf/cwpe20114.pdf

Open Access Link: https://doi.org/10.17863/CAM.62849

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