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The ICA-based Factor Decomposition of the Eurozone Sovereign CDS Spreads

Author

Listed:
  • Frank J. Fabozzi

    (Professor of Finance, EDHEC Business School (E-mail: frank.fabozzi@edhec.edu))

  • Rosella Giacometti

    (Associate Professor, Department of Management, Economics and Quantitative Methods, University of Bergamo (E-mail: rosella.giacometti@unibg.it))

  • Naoshi Tsuchida

    (Deputy director and Economist, Institute for Monetary and Economic Studies, Bank of Japan (E-mail: naoshi.tsuchida@boj.or.jp))

Abstract
In this paper, we examine the factors driving Eurozone sovereign credit default swap (CDS) spreads during the Eurozone sovereign debt crisis. For identifying factors we utilize independent component analysis (ICA), a technique similar to principal component analysis (PCA). We identify three factors that impact spreads and capture the features specific to the crisis such as the breakup risk of the Eurozone: peripheral factor, global factor, and Eurozone common factor. In contrast, when PCA is applied, only a single factor is identified. Moreover, using ICA with a GARCH model, we show that the source of volatility for CDS spreads shifted from the global factor in 2009 and the peripheral factor in 2010 to the Eurozone common factor in 2012, and that the dynamic correlation reflects the decoupling between low credit countries such as Germany and high credit countries such as Greece. We also show that the goodness-of-fit of the ICA-based model is better than other models used such as the Student-t copula model.

Suggested Citation

  • Frank J. Fabozzi & Rosella Giacometti & Naoshi Tsuchida, 2015. "The ICA-based Factor Decomposition of the Eurozone Sovereign CDS Spreads," IMES Discussion Paper Series 15-E-04, Institute for Monetary and Economic Studies, Bank of Japan.
    • Handle: RePEc:ime:imedps:15-e-04
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    File URL: http://www.imes.boj.or.jp/research/papers/english/15-E-04.pdf
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    References listed on IDEAS

    as
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    Cited by:

    1. Ben R. Craig & Margherita Giuzio & Sandra Paterlini, 2019. "The Effect of Possible EU Diversification Requirements on the Risk of Banks’ Sovereign Bond Portfolios," Working Papers 19-12, Federal Reserve Bank of Cleveland.
    2. Bryan Lim & Stefan Zohren & Stephen Roberts, 2020. "Detecting Changes in Asset Co-Movement Using the Autoencoder Reconstruction Ratio," Papers 2002.02008, arXiv.org, revised Sep 2020.

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    More about this item

    Keywords

    independent component analysis (ICA); credit default swap (CDS); Eurozone sovereign debt crisis; redenomination risk;
    All these keywords.

    JEL classification:

    • C18 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Methodolical Issues: General
    • G01 - Financial Economics - - General - - - Financial Crises
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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