Sovereign contagion risk measure across financial markets in the eurozone: a bivariate copulas and Markov Regime Switching ARMA based approaches

This paper analyzes sovereign risk contagion across financial markets in the eurozone during and after the European debt crisis. A particular focus is made on the causal impact of pre-Brexit and Covid-19 pandemic on the dependence between European markets. We use data set from 28 February 2008 to 11 March 2021 and combine copulas and MRS-ARMA techniques to measure dependence across financial markets and assessing asymmetric dependence structure and regime switching process. We develop a dynamic Kendall’s tau correlation and provide evidence of time-varying dependence structure between several pairwise markets. The dependence structure shows a sharp rise on 23 June 2016, day of the referendum on Brexit. Results indicates that Covid-19 pandemic has intensified dependence and sovereign risk spillovers between sovereign CDS European markets. Significant time-varying characteristics of dynamic dependence structures suggests that fund managers and investors should consider in their investment strategies to manage systemic risk and high-risk investment. The identification of dependence structure regime between global financial markets would enhance response to major crises by investors and policy makers.