Modeling Transmissions of Volatility Shocks: Application to CDS Spreads during the Euro Area Sovereign Crisis

This paper tests empirically the contagion and the transmission mechanism of shocks in volatility between the peripheral Eurozone countries. We use the sovereign CDS spreads and the asymmetric model of dynamic conditional correlation GARCH DCC. We investigate the effects of positive and negative shocks over the long term. We investigate the systemic nature of the crisis in Europe. We implement testing of the non-linearity of propagation mechanisms of shocks through a long-term interdependence VECM model (Johansen co-integration). The generated results show that changes in the index of sovereign CDS have a very significant effect on changes in stock indexes in Europe. This is especially true in the case of Germany and France and the PIIGS countries.