No abstract

The on-going EU sovereign debt crisis is causing great concern about the sustainability of national debt issued by the member states. In this paper, we propose a methodology to estimate the likelihood of the default of one or more countries in the Euro Area by extending the approach in Pianeti et al. (2012) to the case of multiple defaults. We provide an assessment of the marginal, the joint and the conditional default probabilities within the Euro Zone. The adopted measure of systemic risk is the probability of a joint default of the EU countries over a 5 years' time horizon. We find evidence of increasing systemic risk and danger of contagion from early-2007 and more significantly from late 2011 onwards. We show the forecasting capability of the estimated default probabilities through a comparison with the dynamics of a benchmark stock market index which marked the timeline of the recent sovereign debt crisis.

paricular J. Breitung, M. Hallin and M. Marcellino, for useful discussions and valuable comments. Special thanks to the Editors, Eric Hillebrand and Siem Jan Koopman, and two anonymous referee for very helpful comments and suggestions that greatly helped to improve the paper. Riccardo Borghi has provided very insightful comments on a previous version of the paper. The usual disclaimer applies. Riccardo Pianeti acknowledges …nancial support from the Centre for Econometric Analisis at Cass and the EAMOR Doctoral Programme at Bergamo University.y KNG Securities, London (UK). We propose a novel dynamic factor model to characterise comovements between returns on securities from di¤erent asset classes from di¤erent countries. We apply a global-classcountry latent factor model and allow time-varying loadings. We are able to separate contagion (asset exposure driven) and excess interdependence (factor volatility driven). Using data from 1999 to 2012, we …nd evidence of contagion from the US stock market during the 2007-09 …nancial crisis, and of excess interdependence during the European debt crisis fromMay-2010 onwards. Neither contagion nor excess interdependence is found when the average measure of model implied comovements is used.JEL: C3, C5, G1.