This paper examines sovereign risk contagion by measuring pair-wise dynamic dependences among weekly CDS spreads of four East-Asian economies (China, Hong Kong, Japan and Korea) for the period from January 2005 to September 2015. We filter the CDS spreads using AR-GARCH-t models controlling for global and economy-specific factors to prevent potential biases of testing for financial contagion. Then we apply mixture of conditional (time-varying) Gaussian and symmetrized Joe-Clayton copulas to the standardized residuals for modeling dependence. In this paper, contagion is defined as a significant increase in markets’ dependence due to an economy-specific shock. We first find that there exists contagion between the Asian sovereign CDS markets. Second, the perceived impact of contagion could be different according to whether it is measured by linear (Gaussian) or tail dependence. Third, our mixture of copulas approach successfully reflects this heterogeneity of sovereign risk contagion and shows that the linear and the upper tail dependences trade off each other once contagion occurs. Lastly, our results indicate that Japan plays the most important role in the Asian sovereign CDS market in terms of the linear dependence whereas China and Korea are crucial in terms of the upper tail dependence.
JEL classification: C51; F3; G01; G15; H63
Keywords: Asian Economies, Contagion, Credit Default Swap, Mixture of Time-varying Copulas, Sovereign Risk
