Modelling Stability of Sovereign Credit Markets and Systems

Reinhard Fellmann
London School of Economics and Political Science
Department of Statistics and Department of Finance

The scaling behaviour of sovereign credit default swap (SCDS) data is studied in terms of the generalized Hurst exponent (GHE) approach to evaluate the level of stability/instability in sovereign credit markets in the European Monetary Union (EMU) over a time period from 2003 to 2013. We find that the decrease of fractal dimension with time may re?ect that the action of anisotropy (directional dependence) inherent to the financial system leads to the appearance of preferred directions of activities (herd behaviour) before a system shock. During the European debt-crisis, sovereign credit markets, in particular peripheral countries (Greece, Italy, Portugal and Spain) transition to a less orderly (unstable) state. The results also indicate that the level of risk is not necessarily a measure of market stability. Further, the processes underlying the SCDS dynamics of countries are truly multi-scaling, which has major implications for derivative pricing.

Keywords: Generalized Hurst Exponent, Credit Default Swaps, Stability, Multi-Scaling

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