The impacts of financial crisis on sovereign credit risk analysis in Asia and Europe

In this paper, we investigate the nature of sovereign credit risk for selected Asian and European countries based on a set of sovereign CDS data over an eight-year period that includes the episode of the 2007-2008 global financial crisis. Our results indicate that there exists strong commonality in sovereign credit risk among the countries studied in this paper following the crisis. In addition, our results also show that commonality is importantly associated with both local and global financial and economic variables. However, there are markedly different impacts of the sovereign of credit risk in Asian and European countries. Specifically, we find that foreign reserve, global stock market, and volatility risk premium, affect Asian and European sovereign credit risks in the opposite direction. Lastly, we model the arrival rates of credit events as a square-root diffusion process from which a pricing model is constructed and estimated over pre-and post-crisis periods. Then the resulting model is used to decompose credit spreads into risk premium and credit-event components. For most countries in our study, credit-event components appear to weight more than risk-premiums.