SOVEREIGN CREDIT RISK (March 2016)
(with Pietro Veronesi)
in Handbook of Fixed-Income Securities, edited by Pietro Veronesi, Wiley [Handbook]
This chapter reviews recent techniques to model sovereign credit risk
and applies them to the credit markets of both emerging and European economies. It shows how to model the sovereign credit risk in a reduced-form setting and how to price credit default swap (CDS) contracts written on sovereign debt. The modeling framework enables to decompose the credit spread into two components: the credit risk premium and the default risk. The former captures the compensation investors demand for bearing the risk due to unexpected variations in the default intensity, whereas the upon default the default risk captures the real probability of default of a country or of an institution. The chapter then describes how to estimate the pricing model with market data using the Quasi-maximum likelihood estimator (MLE) that exploits the features of the probability distribution of the default intensity to match actual CDS spreads.
THE IMPACT OF SOVEREIGN SHOCKS (November2018)
(with Antonio Picca)
listed among the seven best academic research ideas by Wolfe Research, December 2016
- (Python API and Guide) Data & Codes
- Slide AFA 2017
*This paper was previously circulated under the title “The Sovereign Nature of Systemic Risk.”
This paper studies the dynamic propagation mechanisms of systemic risk shocks within and across macro-systems of governments and financial institutions.
We propose a novel approach to identify relevant systemic shocks and to classify them into sovereign or banking categories. We find that sovereign shocks have a significant and persistent impact on the probability of a collective banking default. We also explore channels through which these shocks propagate and identify how sovereign fiscal fragility and banking exposure are relevant mechanisms of shock transmission.
CREDIT-IMPLIED VOLATILITY (October 2016)
(with Bryan Kelly and Diogo Palhares)
winner of the 2016 Jack Treynor Prize (Q-Group), October 2016
The pricing of corporate credit can be succinctly understood via the credit-implied volatility (CIV) surface.
We invert it each month from the firm-by-maturity panel of CDS spreads via the Merton model, transforming CDS spreads into units of asset volatility. The CIV surface facilitates direct comparison of credit spreads at different “moneyness” (firm leverage) and time to maturity. We use this framework to organize the behavior of corporate credit markets into three stylized facts. First, CIV exhibits a steep moneyness smirk: Low leverage (out-of-the-money) CDS trade at a large implied volatility premium relative to highly levered (at-the-money) CDS, holding all other firm characteristics fixed. Second, the dynamics of credit spreads can be described with three clearly interpretable factors driving the entire CIV surface. Third, the cross section of CDS risk premia is fully explained by exposures to CIV surface shocks. Using a structural model for joint asset behavior of all firms, we show that the shape of the CIV surface is consistent with an aggregate asset growth process characterized by stochastic volatility and severe, time-varying downside tail risk. Lastly, we document these same CIV patterns among other credit instruments including corporate bonds and sovereign CDS.
POLITICAL UNCERTAINTY, CREDIT RISK PREMIUM, AND DEFAULT RISK (August 2013)
John A. Doukas Doctoral Best Paper Award, June 2014
I empirically decompose sovereign credit spreads into a default-risk component and its associated (credit) risk premium and study
the effect of political uncertainty on them. On average, credit risk premia account for 42 percent of the observed spreads in the European sovereign credit market. I find that a 10 percent increase in political uncertainty leads to a 3 percent increase in both components after a month. A regional-level analysis reveals heterogeneity in the response of sovereign risk to variations in political uncertainty. This work enriches the understanding of how macroeconomic forces drive variations in sovereign risk and introduces political uncertainty as a significant factor driving the European credit market.
Ph.D. and Master Dissertations