Nonlinearities in the oil effects on the sovereign credit risk: A self-exciting threshold autoregression approach

The unquenchable thirst of several sectors to crude oil in the recent years makes a common belief regarding its key role towards the acceleration of the recent economic recession and financial instability. This paper aims to examine the nonlinear impact of oil shocks on the sovereign credit risk for a sample of 38 worldwide oil-producing and oil-consuming countries, over a period ranging from January 2006 to March 2017. In contrast to the existing literature, CDS volatility is employed as a measure for the creditworthiness level, rather than the commonly used CDS spreads first-order moment. The methodological framework used in this paper goes beyond previous studies and takes into account more financial data features (long memory behavior, asymmetric effects and nonlinearities) according to a self-exciting regime switching model. Results reveal some dissimilarities in the explanatory power of the exogenous variables between regimes and across countries. Particularly, restricted evidences of the impact of oil shocks on sovereign CDS volatility are detected during the stable regime, whilst during the risky regime credit volatility becomes more sensitive to oil market conditions for most of the studied countries. Overall, the decline in oil price worsens the public finances tenability whether the country is oil-related or not.