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Do Energy and Banking CDS Sector Spreads Reflect Financial Risks and Economic Policy Uncertainty? A Time-Scale Decomposition Approach

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Abstract

The aim of this study is to investigate the dynamics of the co-movements of energy and banking sector credit default swaps (CDS) spreads with global financial and economic policy uncertainty and risk factors in the United States and Europe. We first employ the standard quantile regression approach to examine the co-movement dynamics under different credit market conditions. The empirical results show that the standard quantile regression fails to capture the co-movement between the U.S. and European CDS spreads and the economic policy uncertainty and risk factors for all quantiles. However, after decomposing the raw series at various scales of resolution, using the wavelet approach to capture the structure, we find that the financial and energy related CDS spreads co-move with the economic policy uncertainty and stock market risk in the intermediate and lower frequency domain. That is, there is a dependency in the intermediate and higher time scales or the intermediate and long investment horizons for both the United States and Europe. However, there are positive effects of the stock market risk index on the U.S. banking CDS spreads, which remain almost similar across quantiles, but the effects are asymmetric for the European banking spreads. The study also provides policy implications.

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Notes

  1. See the CNBC report on January 20, 2016: http://www.cnbc.com/2016/01/19/oil-prices-fall-further-on-glut-worries-us-crude-slumps-below-28.html.

  2. The MOVE index was created in 1988 and measures bond market volatility by gauging options contracts on one-month Treasury issues.

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Authors and Affiliations

  1. Department of Finance and Investment, College of Economics and Administrative Sciences, Al Imam Mohammad Ibn Saud Islamic University (IMSIU), PO Box 5701, Riyadh, Saudi Arabia

    Nader Naifar

  2. Lebow College of Business, Drexel University, Philadelphia, USA

    Shawkat Hammoudeh

  3. Montpellier Business School, Montpellier, France

    Shawkat Hammoudeh

  4. Energy and Development Sustainability, Montpellier Business School, Montpellier, France

    Aviral Kumar Tiwari

Authors
  1. Nader Naifar
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  2. Shawkat Hammoudeh
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  3. Aviral Kumar Tiwari
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Correspondence to Nader Naifar.

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Naifar, N., Hammoudeh, S. & Tiwari, A.K. Do Energy and Banking CDS Sector Spreads Reflect Financial Risks and Economic Policy Uncertainty? A Time-Scale Decomposition Approach. Comput Econ 54, 507–534 (2019). https://doi.org/10.1007/s10614-018-9838-1

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