Contagion in the Euro area sovereign CDS market: a spatial approach

Abstract

Purpose

This paper explores whether the Euro-area sovereign credit default swap market is prone to contagion effects. It investigates whether the sharp increase in sovereign CDS spread of a given country is due to a deterioration of the macroeconomic variables or some form of contagion.

Design/methodology/approach

For this purpose, the authors use an innovative approach, i.e. spatial econometrics. Although modeling spatial dependence is an attractive challenge, its application in the field of finance remains limited.

Findings

The empirical findings show strong evidence of spatial dependence highlighting the presence of pure contagion. Furthermore, evidence of wake-up call contagion-increased sensitivity of investors to fundamentals of neighboring countries and shift contagion-increased sensitivity to common factors are well recorded.

Originality/value

This study aims to study a crucial financial issue that gained increased research interest, i.e. financial contagion. A methodological contribution is made by extending the standard spatial Durbin model (SDM) to analyze and differentiate between several forms of contagion. The results can be used to understand how shocks are spreading through countries.

Citation

Ben Abdallah, N., Dabbou, H. and Gallali, M.I. (2023), "Contagion in the Euro area sovereign CDS market: a spatial approach", Journal of Risk Finance, Vol. 24 No. 5, pp. 614-630. https://doi.org/10.1108/JRF-10-2022-0283