Assessment of time-varying systemic risk in credit default swap indices: Simultaneity and contagiousness

Abstract

The study aims to assess systemic risk inherent in credit default swap (CDS) indices using empirical and statistical analyses. We define systemic risk from two perspectives: possibilities of simultaneous default and contagious default. We then quantify them separately across benchmark models. To do so, we employ a MarshallOlkin copula model to measure simultaneous default risk, and an interacting intensity based-model to capture contagious default risk. In addition, we select time series models that have minimal prediction errors to forecast the level of systemic risk. For an empirical test, we collect daily data for the iTraxx Europe CDS index and its tranche prices in the period between 2005 and 2014, and calibrate model parameters varying across time. Finally, we examine remarkable changes in each dynamic of systemic risk before and after important credit-related events that have occurred in the global financial and European sovereign debt crises.