Extreme Risk Connectedness of Sovereign Credit Default Swaps: Evidence from BRICS and MIST Countries

Abstract

To analyze the extreme risk spillover effect, this thesis proposes dynamic EVT-VaR extended joint connectedness framework based on extreme value theory. The spillovers among sovereign CDS of BRICS and MIST countries using the data from March 18, 2011 to June 1, 2022 were examined. Global financial factors were included in the model and their effects were analyzed. Besides, using the Principal Component Analysis (PCA), an extreme connectedness analysis was carried out for sovereign CDSs of many leading economies around the world. Moreover, the dynamic EVT-VaR extended joint connectedness framework and the quantile extended joint connectedness approach were compared using sovereign CDSs of BRICS and MIST countries. It has been found that there is a strong connectedness among the sovereign CDSs of the countries in the BRICS and MIST, and the spillover effect has fluctuated over time due to extreme events. Among these countries, Russia has a pronounced role as a net transmitter of shock. After Russia, Mexico has also been one of the important drivers in explaining the variability in the sovereign CDS spreads in BRICS and MIST countries, especially in 2017-2018 and after 2020. Global financial markets have a limited impact on sovereign CDSs in the BRICS and MIST countries. Using the PCA analysis, we found that there is an unprecedented increase for the analysis period in the total connectedness of sovereign CDSs around the world after the Covid 19 pandemic and it continues to remain high at the present time. Finally, the quantile extended joint connectedness approach does not respond as sensitively as the dynamic EVT-VaR extended joint connectedness framework to extreme events that have occurred over time. Another finding of the study is that Türkiye is not strongly interconnected with other economies. As a result of limited interconnectedness, Türkiye have been affected by systematic risks less. On the other hand, Türkiye has a high and volatile sovereign CDS values, which means that the country's high-risk perception stems from events occurring within the country itself, rather than external factors.