Unveiling trading patterns: iTraxx Europe financials from the great financial crisis to ECB monetary easing

  • Received August 24, 2022;
    Accepted September 23, 2022;
    Published September 29, 2022
  • Author(s)
  • DOI
    http://dx.doi.org/10.21511/bbs.17(3).2022.16
  • Article Info
    Volume 17 2022, Issue #3, pp. 188-200
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This work is licensed under a Creative Commons Attribution 4.0 International License

Financial stability is a statutory concern of the European Central Bank. Spreads of bank credit default swaps (CDS) indices are a reference for financial stability, but the literature is scarce in this respect. This paper poses the novel research question of which characteristics of investors in these derivatives are implied by the volatility behavior of the returns of financial CDS indices. Daily spread returns for the 5-year maturity iTraxx Europe Financials (subordinated and senior), for the period between June 2004 and March 2015, are used to estimate a GJR-M model with Student t innovations, and two MGARCH models (one with constant and the other with dynamic conditional correlations). The results show that investors in the index referring to subordinated debt are risk averse (risk premium estimate of 0.688) and liable to leverage effects, while investors in the index for senior debt do not have such characteristics. The degrees of freedom of the Student t innovations are estimated to be 4 for both indices, implying that returns have distributions with very fat tails. Population excess kurtosis diverges to infinity. The results show that the conditional correlation between the indices is dynamic. Although correlations vary widely, most of that variation occurs before the Euro Area crisis. It is concluded that the inclusion of both indices in a portfolio would be misadvised for bear markets with distressed financial entities: the correlations are always positive, above 0.75 since 2010. Moreover, both indices prove to be sensitive to the varying surrounding conditions as investors share market sentiments.

Acknowledgments
NECE’s research is funded by national funds through FCT – Fundação para a Ciência e a Tecnologia, I.P., Project UIDB/04630/2020
CEBER’s research is funded by national funds through FCT – Fundação para a Ciência e a Tecnologia, I.P., Project UIDB/05037/2020

 

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    • Figure 1. Dynamic conditional correlations from MGARCH-DCC
    • Figure 2. iTraxx Financials Europe spreads for subordinated and senior debt
    • Table 1. Estimation results for the GJR (1,1)_t-M model of the iTraxx returns
    • Conceptualization
      Maria Alberta Oliveira, Carlos Santos
    • Data curation
      Maria Alberta Oliveira, Carlos Santos
    • Formal Analysis
      Maria Alberta Oliveira, Carlos Santos
    • Funding acquisition
      Maria Alberta Oliveira, Carlos Santos
    • Investigation
      Maria Alberta Oliveira, Carlos Santos
    • Methodology
      Maria Alberta Oliveira, Carlos Santos
    • Project administration
      Maria Alberta Oliveira, Carlos Santos
    • Resources
      Maria Alberta Oliveira, Carlos Santos
    • Software
      Maria Alberta Oliveira, Carlos Santos
    • Supervision
      Maria Alberta Oliveira, Carlos Santos
    • Validation
      Maria Alberta Oliveira, Carlos Santos
    • Visualization
      Maria Alberta Oliveira, Carlos Santos
    • Writing – original draft
      Maria Alberta Oliveira, Carlos Santos
    • Writing – review & editing
      Maria Alberta Oliveira, Carlos Santos