The causal relationships between sovereign CDS premiums for Japan and selected EU countries

Abstract

In this article, we apply the cross-correlation function approach developed by Hong (2001) in order to investigate how the recent sovereign debt crisis has influenced interrelations between sovereign credit default swap (CDS) premiums for Japan and for Europe's major countries. We confirm the existence of a causal linkage between the mean of Japan and those of EU countries except Greece. In addition, this causal linkage has strengthened remarkably since the crisis. Further, we detect a causal linkage in terms of variance between Japan and certain EU countries including Greece.

Keywords:

• sovereign CDS premiums
• cross-correlation function approach
• AR-EGARCH
• causality in mean
• causality in variance

JEL Classification:

• C22
• C29
• G15

Notes

¹A CDS is a type of credit derivative that involves the purchases and sales of protection against credit risks of a firm or sovereign entity. CDS premiums are the annual cost expressed in basis points against the face value.

² To determine the optimal lag length k, p and q for each CDS premiums series, the Schwarz Baysian Information Criterion (SBIC) is employed. Stationarity for the first difference of CDS premium series is checked using Augmented Dickey–Fuller tests.