In this paper, we examine the factors driving Eurozone sovereign credit default swap (CDS) spreads during the Eurozone sovereign debt crisis. For identifying factors we utilize independent component analysis (ICA), a technique similar to principal component analysis (PCA). We identify three factors that impact spreads and capture the features specific to the crisis such as the breakup risk of the Eurozone: peripheral factor, global factor, and Eurozone common factor. In contrast, when PCA is applied, only a single factor is identified. Moreover, using ICA with a GARCH model, we show that the source of volatility for CDS spreads shifted from the global factor in 2009 and the peripheral factor in 2010 to the Eurozone common factor in 2012, and that the dynamic correlation reflects the decoupling between low credit countries such as Germany and high credit countries such as Greece. We also show that the goodness-of-fit of the ICA-based model is better than other models used such as the Student-t copula model.
Keywords: independent component analysis (ICA); credit default swap (CDS); Eurozone sovereign debt crisis; redenomination risk
Views expressed in the paper are those of the authors and do not necessarily reflect those of the Bank of Japan or Institute for Monetary and Economic Studies.