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An Empirical Study on the Correlation Structure of Credit Spreads based on the Dynamic and Pair Copula Functions

An Empirical Study on the Correlation Structure of Credit Spreads based on the Dynamic and Pair... PurposeThe paper aims to study the correlation structure of the credit spreads.Design/methodology/approachThe minimal spanning tree is used to find the risk center node and the basic correlation structure of the credit spread. The dynamic Copula and Pair Copula models are applied to capture the dynamic and nonlinear correlation structure. FindingsWe take the enterprise bond with trading data from January 2013 to December 2013 as the research sample. The empirical study of minimum spanning tree shows that the credit risk of corporate bonds forms a network structure with a center node. Meanwhile, the correlation between credit spreads shows dynamic characteristics. Under the framework of dynamic copula, the lower tail dependence is less than the upper tail dependence, thus, in economic boom period, the dynamic correlation is more significant than in recession period. We also find that the centrality of credit risk network is not significant according to the pair copula and Granger causality test. The empirical study shows that the goodness-of-fit of D vine is superior to Canonical vine, and the Granger causality test additionally proves that the center node has influence on few other nodes in the risk network, thus the center node captured by the minimum spanning tree is a weak center node, and this characteristic of credit risk network indicates that the risk network of credit spreads is generated mostly by the external shocks rather than the internal risk contagion.Originality/valueThis paper provides new ideas for investors and researchers to analyze the credit risk correlation or contagion. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png China Finance Review International Emerald Publishing

An Empirical Study on the Correlation Structure of Credit Spreads based on the Dynamic and Pair Copula Functions

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Publisher
Emerald Publishing
Copyright
Copyright © Emerald Group Publishing Limited
ISSN
2044-1398
DOI
10.1108/CFRI-08-2015-0118
Publisher site
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Abstract

PurposeThe paper aims to study the correlation structure of the credit spreads.Design/methodology/approachThe minimal spanning tree is used to find the risk center node and the basic correlation structure of the credit spread. The dynamic Copula and Pair Copula models are applied to capture the dynamic and nonlinear correlation structure. FindingsWe take the enterprise bond with trading data from January 2013 to December 2013 as the research sample. The empirical study of minimum spanning tree shows that the credit risk of corporate bonds forms a network structure with a center node. Meanwhile, the correlation between credit spreads shows dynamic characteristics. Under the framework of dynamic copula, the lower tail dependence is less than the upper tail dependence, thus, in economic boom period, the dynamic correlation is more significant than in recession period. We also find that the centrality of credit risk network is not significant according to the pair copula and Granger causality test. The empirical study shows that the goodness-of-fit of D vine is superior to Canonical vine, and the Granger causality test additionally proves that the center node has influence on few other nodes in the risk network, thus the center node captured by the minimum spanning tree is a weak center node, and this characteristic of credit risk network indicates that the risk network of credit spreads is generated mostly by the external shocks rather than the internal risk contagion.Originality/valueThis paper provides new ideas for investors and researchers to analyze the credit risk correlation or contagion.

Journal

China Finance Review International – Emerald Publishing

Published: Aug 15, 2016

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