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The Relationship Between Volatility and Sovereign Credit Risk in the Emerging Markets: A Nonlinear ARDL Approach

Year 2022, Volume: 22 Issue: 1, 49 - 58, 30.01.2022
https://doi.org/10.21121/eab.1064521

Abstract

This study investigates the short- and long-run nexus between the volatility index of VIX and sovereign credit risk represented by CDS spread in emerging markets, namely Turkey, China, Russia, Brazil, and Mexico. The emerging markets are at the center of investors’ interest due to high return opportunities. The relationship between volatility and sovereign
credit risk has been studied many times via linear models. However, financial series exhibit asymmetric dynamics, as volatility clustering, excess kurtosis, and others. Thus, we use nonlinear autoregressive distributed lags (NARDL) analysis to capture nonlinear relations between the volatility and the sovereign credit risks of these countries by using daily data
from 04.01.2010 to 29.11.2019. The bounds test of the NARDL model confirms the cointegration between VIX and CDS spreads of the countries under study. The analysis of estimated NARDL parameters shows that negative shocks of the volatility index have a long-lasting impact on CDS spreads. Chinese CDS spread are more sensitive to VIX index changes
in the short run. The effect of a decrease in volatility on Russian CDS spread is higher than the effect of an increase. Turkish and Brazilian CDS spreads are more reactive to increase in the VIX, whereas Mexican CDS is less sensitive. These findings show that investors, arbitrageurs and speculators should consider global indicators when taking a position on sovereign
bonds of emerging markets.

References

  • Agliardi, E., Agliardi, R., Pinar, M., Stengos, T., & Topaloglou, N. (2012). A new country risk index for emerging markets: A stochastic dominance approach. Journal of Empirical Finance, 19(5), 741-761.
  • Aliyev, F. (2019). Testing market efficiency with nonlinear methods: Evidence from Borsa Istanbul. International Journal of Financial Studies, 7(2), 27.
  • Aliyev, F., Ajayi, R., & Gasim, N. (2020). Modelling asymmetric market volatility with univariate GARCH models: Evidence from Nasdaq-100. The Journal of Economic Asymmetries, 22, e00167.
  • Alqaralleh, Huthaifa (2020). Stock return-inflation nexus; revisited evidence based on nonlinear ARDL Journal of Applied Economics, 23(1), 66-74.
  • Andersen, T. G., Bollerslev, T., Diebold, F. X., & Ebens, H. (2001). The distribution of realized stock return volatility. Journal of Financial Economics, 61(1), 43-76.
  • Ballester, L., & González-Urteaga, A. (2017). How credit ratings affect sovereign credit risk: Cross-border evidence in Latin American emerging markets. Emerging Markets Review, 30, 200-214.
  • Borri, N., & Verdelhan, A. (2011). Sovereign risk premia. Paper presented at the AFA 2010 Atlanta Meetings Paper.
  • Cantor, R., & Packer, F. (1996). Sovereign risk assessment and agency credit ratings. European Financial Management, 2(2), 247-256.
  • Chan-Lau, J. A., & Kim, Y. S. (2004). Equity prices, credit default swaps, and bond spreads in emerging markets (WP/04/27).
  • Chan, K. C., Fung, H.-G., & Zhang, G. (2009). On the relationship between asian sovereign credit default swap markets and equity markets. Journal of Asian Business Studies, 4(1), 3-12.
  • Chuffart, T., & Hooper, E. (2019). An investigation of oil prices’ impact on sovereign credit default swaps in Russia and Venezuela. Energy Economics, 80, 904-916.
  • Dickey, D. A., & Fuller, W. A. (1981). Likelihood ratio statistics for autoregressive time series with a unit root. Econometrica: Journal of the Econometric Society, 49(4), 1057-1072.
  • Enders, W., & Lee, J. (2012). The flexible Fourier form and Dickey– Fuller type unit root tests. Economics Letters, 117(1), 196-199.
  • Engle, R. F., & Granger, C. W. (1987). Co-integration and error correction: representation, estimation, and testing. Econometrica: Journal of the Econometric Society, 55(2), 251-276.
  • Eyssell, T., Fung, H.-G., & Zhang, G. (2013). Determinants and price discovery of China sovereign credit default swaps. China Economic Review, 24, 1-15.
  • Figuerola-Ferretti, I., & Paraskevopoulos, I. (2013). Pairing market risk and credit risk. Available at SSRN 1553863.
  • Harvey, C. R. (1995). Predictable risk and returns in emerging markets. The Review of Financial Studies, 8(3), 773-816.
  • Hilscher, J., & Nosbusch, Y. (2010). Determinants of sovereign risk: Macroeconomic fundamentals and the pricing of sovereign debt. Review of Finance, 14(2), 235-262.
  • Ismailescu, I., & Kazemi, H. (2010). The reaction of emerging market credit default swap spreads to sovereign credit rating changes. Journal of Banking & Finance, 34(12), 2861-2873.
  • Jeanneret, A. (2015). The dynamics of sovereign credit risk. Journal of Financial and Quantitative Analysis, 50(5), 963-985.
  • Johansen, S., & Juselius, K. (1990). Maximum likelihood estimation and inference on cointegration—with appucations to the demand for money. Oxford Bulletin of Economics and Statistics, 52(2), 169-210.
  • Larraín, G., Reisen, H., & Von Maltzan, J. (1997). Emerging market risk and sovereign credit ratings. OECD Development Centre Working Paper, 124, 1-30.
  • Longstaff, F. A., Pan, J., Pedersen, L. H., & Singleton, K. J. (2011). How sovereign is sovereign credit risk? American Economic Journal: Macroeconomics, 3(2), 75-103.
  • Luukkonen, R., Saikkonen, P., & Teräsvirta, T. (1988). Testing linearity against smooth transition autoregressive models. Biometrika, 75(3), 491-499.
  • Maltritz, D., & Molchanov, A. (2014). Country credit risk determinants with model uncertainty. International Review of Economics & Finance, 29, 224-234.
  • Merton, R. C. (1974). On the pricing of corporate debt: The risk structure of interest rates. The Journal of Finance, 29(2), 449- 470.
  • Narayan, P. K. (2005). The saving and investment nexus for China: evidence from cointegration tests. Applied Economics, 37(17), 1979-1990.
  • Pan, J., & Singleton, K. J. (2008). Default and recovery implicit in the term structure of sovereign CDS spreads. The Journal of Finance, 63(5), 2345-2384.
  • Patel, S. A., & Sarkar, A. (1998). Crises in developed and emerging stock markets. Financial Analysts Journal, 54(6), 50-61.
  • Pesaran, M. H., Shin, Y., & Smith, R. J. (2001). Bounds testing approaches to the analysis of level relationships. Journal of Applied Econometrics, 16(3), 289-326.
  • Phillips, P. C., & Perron, P. (1988). Testing for a unit root in time series regression. Biometrika, 75(2), 335-346.
  • Remolona, E. M., Scatigna, M., & Wu, E. (2008). The dynamic pricing of sovereign risk in emerging markets: Fundamentals and risk aversion. The Journal of Fixed Income, 17(4), 57-71.
  • Ricciardi, A. (2016). Exploiting the cointrgration between VIX and CDS in a credit market timing model.Unpublished Doctoral Dissertation.
  • Shahzad, S. J. H., Nor, S. M., Ferrer, R., & Hammoudeh, S. (2017). Asymmetric determinants of CDS spreads: US industry-level evidence through the NARDL approach. Economic Modelling, 60, 211-230.
  • Shin, Y., Yu, B., & Greenwood-Nimmo, M. (2014). Modelling asymmetric cointegration and dynamic multipliers in a nonlinear ARDL framework. In R. C. Sickles & W. C. Horrace (Eds.), Festschrift in Honor of Peter Schmidt (pp. 281-314). New York, NY: Springer.
  • Sturzenegger, F., & Zettelmeyer, J. (2006). Debt Defaults and Lessons from a Decade of Crises: MIT Press.
  • Weigel, D. D., & Gemmill, G. (2006). What drives credit risk in emerging markets? The roles of country fundamentals and market co-movements. Journal of International Money and Finance, 25(3), 476-502
Year 2022, Volume: 22 Issue: 1, 49 - 58, 30.01.2022
https://doi.org/10.21121/eab.1064521

Abstract

References

  • Agliardi, E., Agliardi, R., Pinar, M., Stengos, T., & Topaloglou, N. (2012). A new country risk index for emerging markets: A stochastic dominance approach. Journal of Empirical Finance, 19(5), 741-761.
  • Aliyev, F. (2019). Testing market efficiency with nonlinear methods: Evidence from Borsa Istanbul. International Journal of Financial Studies, 7(2), 27.
  • Aliyev, F., Ajayi, R., & Gasim, N. (2020). Modelling asymmetric market volatility with univariate GARCH models: Evidence from Nasdaq-100. The Journal of Economic Asymmetries, 22, e00167.
  • Alqaralleh, Huthaifa (2020). Stock return-inflation nexus; revisited evidence based on nonlinear ARDL Journal of Applied Economics, 23(1), 66-74.
  • Andersen, T. G., Bollerslev, T., Diebold, F. X., & Ebens, H. (2001). The distribution of realized stock return volatility. Journal of Financial Economics, 61(1), 43-76.
  • Ballester, L., & González-Urteaga, A. (2017). How credit ratings affect sovereign credit risk: Cross-border evidence in Latin American emerging markets. Emerging Markets Review, 30, 200-214.
  • Borri, N., & Verdelhan, A. (2011). Sovereign risk premia. Paper presented at the AFA 2010 Atlanta Meetings Paper.
  • Cantor, R., & Packer, F. (1996). Sovereign risk assessment and agency credit ratings. European Financial Management, 2(2), 247-256.
  • Chan-Lau, J. A., & Kim, Y. S. (2004). Equity prices, credit default swaps, and bond spreads in emerging markets (WP/04/27).
  • Chan, K. C., Fung, H.-G., & Zhang, G. (2009). On the relationship between asian sovereign credit default swap markets and equity markets. Journal of Asian Business Studies, 4(1), 3-12.
  • Chuffart, T., & Hooper, E. (2019). An investigation of oil prices’ impact on sovereign credit default swaps in Russia and Venezuela. Energy Economics, 80, 904-916.
  • Dickey, D. A., & Fuller, W. A. (1981). Likelihood ratio statistics for autoregressive time series with a unit root. Econometrica: Journal of the Econometric Society, 49(4), 1057-1072.
  • Enders, W., & Lee, J. (2012). The flexible Fourier form and Dickey– Fuller type unit root tests. Economics Letters, 117(1), 196-199.
  • Engle, R. F., & Granger, C. W. (1987). Co-integration and error correction: representation, estimation, and testing. Econometrica: Journal of the Econometric Society, 55(2), 251-276.
  • Eyssell, T., Fung, H.-G., & Zhang, G. (2013). Determinants and price discovery of China sovereign credit default swaps. China Economic Review, 24, 1-15.
  • Figuerola-Ferretti, I., & Paraskevopoulos, I. (2013). Pairing market risk and credit risk. Available at SSRN 1553863.
  • Harvey, C. R. (1995). Predictable risk and returns in emerging markets. The Review of Financial Studies, 8(3), 773-816.
  • Hilscher, J., & Nosbusch, Y. (2010). Determinants of sovereign risk: Macroeconomic fundamentals and the pricing of sovereign debt. Review of Finance, 14(2), 235-262.
  • Ismailescu, I., & Kazemi, H. (2010). The reaction of emerging market credit default swap spreads to sovereign credit rating changes. Journal of Banking & Finance, 34(12), 2861-2873.
  • Jeanneret, A. (2015). The dynamics of sovereign credit risk. Journal of Financial and Quantitative Analysis, 50(5), 963-985.
  • Johansen, S., & Juselius, K. (1990). Maximum likelihood estimation and inference on cointegration—with appucations to the demand for money. Oxford Bulletin of Economics and Statistics, 52(2), 169-210.
  • Larraín, G., Reisen, H., & Von Maltzan, J. (1997). Emerging market risk and sovereign credit ratings. OECD Development Centre Working Paper, 124, 1-30.
  • Longstaff, F. A., Pan, J., Pedersen, L. H., & Singleton, K. J. (2011). How sovereign is sovereign credit risk? American Economic Journal: Macroeconomics, 3(2), 75-103.
  • Luukkonen, R., Saikkonen, P., & Teräsvirta, T. (1988). Testing linearity against smooth transition autoregressive models. Biometrika, 75(3), 491-499.
  • Maltritz, D., & Molchanov, A. (2014). Country credit risk determinants with model uncertainty. International Review of Economics & Finance, 29, 224-234.
  • Merton, R. C. (1974). On the pricing of corporate debt: The risk structure of interest rates. The Journal of Finance, 29(2), 449- 470.
  • Narayan, P. K. (2005). The saving and investment nexus for China: evidence from cointegration tests. Applied Economics, 37(17), 1979-1990.
  • Pan, J., & Singleton, K. J. (2008). Default and recovery implicit in the term structure of sovereign CDS spreads. The Journal of Finance, 63(5), 2345-2384.
  • Patel, S. A., & Sarkar, A. (1998). Crises in developed and emerging stock markets. Financial Analysts Journal, 54(6), 50-61.
  • Pesaran, M. H., Shin, Y., & Smith, R. J. (2001). Bounds testing approaches to the analysis of level relationships. Journal of Applied Econometrics, 16(3), 289-326.
  • Phillips, P. C., & Perron, P. (1988). Testing for a unit root in time series regression. Biometrika, 75(2), 335-346.
  • Remolona, E. M., Scatigna, M., & Wu, E. (2008). The dynamic pricing of sovereign risk in emerging markets: Fundamentals and risk aversion. The Journal of Fixed Income, 17(4), 57-71.
  • Ricciardi, A. (2016). Exploiting the cointrgration between VIX and CDS in a credit market timing model.Unpublished Doctoral Dissertation.
  • Shahzad, S. J. H., Nor, S. M., Ferrer, R., & Hammoudeh, S. (2017). Asymmetric determinants of CDS spreads: US industry-level evidence through the NARDL approach. Economic Modelling, 60, 211-230.
  • Shin, Y., Yu, B., & Greenwood-Nimmo, M. (2014). Modelling asymmetric cointegration and dynamic multipliers in a nonlinear ARDL framework. In R. C. Sickles & W. C. Horrace (Eds.), Festschrift in Honor of Peter Schmidt (pp. 281-314). New York, NY: Springer.
  • Sturzenegger, F., & Zettelmeyer, J. (2006). Debt Defaults and Lessons from a Decade of Crises: MIT Press.
  • Weigel, D. D., & Gemmill, G. (2006). What drives credit risk in emerging markets? The roles of country fundamentals and market co-movements. Journal of International Money and Finance, 25(3), 476-502
There are 37 citations in total.

Details

Primary Language English
Subjects Business Administration
Journal Section Articles
Authors

Fatih Yiğit This is me 0000-0002-1988-7962

Fuzuli Aliyev 0000-0001-5851-1581

Publication Date January 30, 2022
Acceptance Date October 22, 2021
Published in Issue Year 2022 Volume: 22 Issue: 1

Cite

APA Yiğit, F., & Aliyev, F. (2022). The Relationship Between Volatility and Sovereign Credit Risk in the Emerging Markets: A Nonlinear ARDL Approach. Ege Academic Review, 22(1), 49-58. https://doi.org/10.21121/eab.1064521
AMA Yiğit F, Aliyev F. The Relationship Between Volatility and Sovereign Credit Risk in the Emerging Markets: A Nonlinear ARDL Approach. ear. January 2022;22(1):49-58. doi:10.21121/eab.1064521
Chicago Yiğit, Fatih, and Fuzuli Aliyev. “The Relationship Between Volatility and Sovereign Credit Risk in the Emerging Markets: A Nonlinear ARDL Approach”. Ege Academic Review 22, no. 1 (January 2022): 49-58. https://doi.org/10.21121/eab.1064521.
EndNote Yiğit F, Aliyev F (January 1, 2022) The Relationship Between Volatility and Sovereign Credit Risk in the Emerging Markets: A Nonlinear ARDL Approach. Ege Academic Review 22 1 49–58.
IEEE F. Yiğit and F. Aliyev, “The Relationship Between Volatility and Sovereign Credit Risk in the Emerging Markets: A Nonlinear ARDL Approach”, ear, vol. 22, no. 1, pp. 49–58, 2022, doi: 10.21121/eab.1064521.
ISNAD Yiğit, Fatih - Aliyev, Fuzuli. “The Relationship Between Volatility and Sovereign Credit Risk in the Emerging Markets: A Nonlinear ARDL Approach”. Ege Academic Review 22/1 (January 2022), 49-58. https://doi.org/10.21121/eab.1064521.
JAMA Yiğit F, Aliyev F. The Relationship Between Volatility and Sovereign Credit Risk in the Emerging Markets: A Nonlinear ARDL Approach. ear. 2022;22:49–58.
MLA Yiğit, Fatih and Fuzuli Aliyev. “The Relationship Between Volatility and Sovereign Credit Risk in the Emerging Markets: A Nonlinear ARDL Approach”. Ege Academic Review, vol. 22, no. 1, 2022, pp. 49-58, doi:10.21121/eab.1064521.
Vancouver Yiğit F, Aliyev F. The Relationship Between Volatility and Sovereign Credit Risk in the Emerging Markets: A Nonlinear ARDL Approach. ear. 2022;22(1):49-58.