Search Results (6)

In this paper, we analysed several emerging market (EM) and developed market (DM) sovereign yield curves to identify the proportion of parallel and non-parallel shifts over time. We found that non-parallel shifts are more prevalent in EM due to higher political and economic risks. Key drivers include systemic risk events like wars, debt distress, and pandemics. By backtesting a long butterfly strategy to extract non-parallel risk premia from June 2007 to March 2024, we observed that steeper slopes and greater curvature result in higher returns. We also quantified monetary and fiscal regimes to determine what types of policies are required to extract non-parallel risk premia from these sovereign yield curves. Our research suggests that countries with opposing monetary and fiscal policies possess higher return opportunities whilst countries with complementing policies require tactical butterfly strategies to optimise returns. Full article

The recent financial crisis offered an interesting opportunity to analyze the markets’ behavior in a high-volatility framework. In this paper, we analyzed the price discovery process of the Italian banks’ Credit Default Swap (CDS) spreads through the Merton model, extended with the inclusion of a redenomination risk proxy, as to say, the risk that Italy could leave the eurozone. This paper contributes to the literature by integrating the classic Merton model with a political-sensitive market variable able to explain the greatest variance in the Italian banks’ CDS spreads during the most relevant and commonly recognized periods of socio-political and financial distress. Results show that the redenomination risk is progressively becoming the main driver of the process during crises, in particular for the sovereign debt crisis and in 2018. Full article

We investigate the tail dependence between sovereign debt distress and bank non-performing loans (NPLs) using a large sample of developed and emerging countries in recent decades. Considering the feedback loop of sovereign debt and bank loan distress, we use three copula models to analyze the asymmetry of tail dependence structure between sovereign debt exposure and bank NPLs. We use the Gaussian copula marginal regression to control the concurrent impact of other macroeconomic variables. We provide evidence that sovereign debt indicates an important determinant of NPLs. We also find that there is tail dependence between sovereign debt distress and bank NPLs, whereas the tail dependence coefficients vary across countries. Our findings shed light on the influence of fiscal distress on bank loan distress and provide immediate implications for the design of macro prudential and financial policy. Full article

This article visualizes bank non-performing loans (NPLs) and government debt distress data integration and an outcome classification after the outbreak of European sovereign debt. Linear and functional principal component analysis (FPCA) and biclustering are used to show the clustering pattern of NPLs and government debt for 25 EU and BRICS countries (Brazil, Russia, India, China and South Africa) during the period of 2006 to 2017 through high-dimensional visualizations. The results demonstrate that the government debt markets of EU countries experienced a similar trend in terms of NPLs, with a similar size of NPLs across debt markets. Through visualization, we find that the government debt and NPLs of EU and BRICS countries increased drastically after the crisis, and crisis countries are contagious. However, the impact of the Greek debt crisis is lower for non-crisis countries, because the debt markets of these countries are decoupled from the Greek market. We also find that sovereign debtors in the EU countries have much closer fiscal linkages than BRICS countries. The level of crisis in the EU countries will be higher than that in the BRICS countries if crisis is driven by the common shocks of macroeconomic fundamentals. Full article

Following the financial crisis of 2007 and the sovereign debt crisis in 2010 that affected the soundness and reduced the strength of public finance in European countries, there has been a growing interest in developing methodologies to the help assess and signal the vulnerability of fiscal policy. Therefore, the aim of this study is to develop a new framework (V-L-D) to assess fiscal vulnerability. V-L-D represents a new methodology on the measurement of fiscal vulnerability that relies on the assumption that vulnerability can occur even during calm times. In comparison with previous methodologies that studied fiscal vulnerability around crisis and fiscal distress times, our framework investigates fiscal vulnerability near fiscal adjustments episodes. Our methodology relies on two distinct indicators: one showing the vulnerabilities indicated by the level of the cyclically adjusted budget balance and distance-to-stability, and one showing the vulnerabilities pointed out through the changes of the cyclically adjusted budget balance and public debt. V-L-D is able to classify fiscal vulnerability into five distinct categories having scores from 0 (no fiscal vulnerability) to 4 (extreme fiscal vulnerability). Using annual data ranging over 1990–2013 for 28 European Union countries, we evidenced 310 episodes of fiscal vulnerability, out of which 128 episodes of low vulnerability, 94 of moderate, 62 of strong, and 26 of extreme fiscal vulnerability. We also found that over 2004–2013, Greece, Portugal, Romania, United Kingdom, Ireland, Spain, and Slovenia were the most fiscally vulnerable countries in the Union. United Kingdom and Greece went through the longest episodes of fiscal vulnerability, counting 12 and 11 consecutive years, respectively. We tested our framework’s effectiveness against the Excessive Deficit Procedure. We found that the overall performance is good: V-L-D assessed moderate fiscal vulnerability during the procedure, strong fiscal vulnerability in the first year when procedure was initiated, and extreme vulnerability one year before the initiation. Full article

This paper addresses the relationship between stock markets and credit default swaps (CDS) markets. In particular, I aim to gauge if the co-movement between stock prices and sovereign CDS spreads increases with the deterioration of the credit quality of sovereign debt. The analysis of correlations, Granger causality, cointegration, and the results of an error-correction model represented in a state space form show a close link between these markets, but do not evidence that the co-movement increases in periods of financial distress. I also analyze the transmission of volatility between the two markets. The results do not support the hypothesis that volatility propagation surges during financial distress periods. On the contrary, for some cases, the data suggests that the lead-lag relationships between the two markets volatility are stronger during stable periods. Full article