Volatility transmission among European Bank Cds

AutorAida Alemany - Laura Ballester - Ana González Urteaga
CargoIntermoney Valora Consulting, Madrid, Spain - University of Valencia, Valencia, Spain - Public University of Navarre, Pamplona, Spain
Aida Alemany
Intermoney Valora Consulting, Madrid, Spain
Laura Ballester
University of Valencia, Valencia, Spain
Ana González-Urteaga
Public University of Navarre, Pamplona, Spain
From 2007 subprime crisis to the recent Eurozone debt crisis the European
banking industry has experienced a terrible financial instability situation with increasing
levels of CDS spreads (used as a proxy of credit risk). This paper investigates whether
volatility transmission channels in European banking markets have changed after three
significant crises’ events during the period January 2006 to March 2013. The global
financial crisis is characterized by a unidirectional volatility shocks spillovers effect in
credit risk from inside to outside the Eurozone. By contrast, the Eurozone debt crisis is
revealed to be local in nature with the euro as the key element suggesting a market
fragmentation between distressed peripheral and non-distressed core Eurozone
countries, whereas retaining the local currency have acted as a firewall. With these
findings we are able to shed light on the impact of the different crises on the European
banking credit risk dynamics.
Keywords: CDS spreads, credit risk, volatility spillovers, financial crisis.
JEL-codes: G01, G15, C58.
L. Ballester would like to express her gratitud e for the funding received from UV-INV-PRECOMP-
80704 and A. González-Urteaga acknowledges financial support from ECO2012-35946-C02-01 and
ECO2012-34268. The authors would like to thank Pedro Serrano, Alfonso Novales, Pilar Soriano, Helena
Chuliá and J uan Ángel Jiménez for their valuable comments and suggestions. Corresponding author:
A partir de la crisis subprime en 2007 y hasta la reciente crisis de deuda de la
zona euro el sector bancario europeo ha experimentado una terrible situación de
inestabilidad financiera traducida en un aumento de los niveles de los CDS (utilizados
como aproximación del riesgo de crédito). Este trabajo investiga si los canales de
transmisión de volatilidad en los mercados bancarios europeos han cambiado después
de tres importantes eventos de crisis durante el período comprendido entre enero de
2006 y marzo de 2013. La crisis financiera global se ha caracterizado por un efecto
spillover unidireccional de los shocks en volatilidad del riesgo de crédito desde el
interior al exterior de la Eurozona. Por el contrario, la crisis de deuda de la Eurozona se
revela como una crisis de naturaleza local con el euro como elemento clave, lo que deja
de manifiesto la existencia de una fragmentación del mercado entre los países
periféricos más castigados por la crisis y los países del centro de la Eurozona con
menores dificultades, mientras que por otro lado, mantener la moneda local ha actuado
como cortafuegos. Estos resultados arrojan luz sobre el impacto del riesgo de crédito
bancario en Europa para diferentes estados de crisis financieras.
Palabras clave: CDS spreads, riesgo de crédito, spillovers de volatilidad, crisis
Indicadores JEL: G01, G15, C58.
In 2007 and after knowing the seriousness of the problems of the real state sector
of the country, the US financial system suffered the called subprime crisis, which was
eventually taking greater dimensions given that many international banks made large
investments in the sector, creating a false wealth. A few months later, Lehman Brothers
Holdings Inc., the fourth largest investment bank in the US, suffered the consequences
of the crisis, announcing the bankruptcy filing.
The serious tensions that emerged in the international financial markets in 2007
and 2008 broke the stability that had characterized the first ten years of the EMU
(European Monetary Union), affecting the real sector and causing a rapid deterioration
in the major economies of Europe, leading to the Eurozone sovereign debt crisis.
In early 2010, concerns in Europe, due to the inability of Greece to hold its debt,
intensified and finally approved a rescue package of 750,000 million euros aimed at
ensuring financial stability in Europe by creating a European Financial Stability Fund
(EFSF). However, these bailouts have not removed the risk, which has been transferred
mainly to governments and taxpayers of other countries. In addition, for the first time,
the current sovereign debt crisis severely tested the robustness of the Eurozone since its
inception in 1999.
We have seen how different financial crisis, originated in particular regions or
countries, have extended geographically. As financial markets are becoming
increasingly integrated and globalized, information generated in one country could
affect other markets, that is shocks originated in one market may be transmitted to other
financial markets. In fact, the vulnerability of the international financial system to
shocks seems to have been increased due to the recent crises, and it has become an
interesting topic analysed by academics and professionals.
After a greater pace of geographic, product diversification, convergence and
consolidation at domestic and international level, the banking industry have witnessed a
terrible instability situation from 2007 to nowadays. Given this background, the
investigation of the degree of interconnectedness and intensity of the interaction among
the global banking industry before and during this turbulent period is imperative. More
specifically, understanding the volatility transmission patterns is crucial for asset

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