Credit risk interdependence in global financial markets: Evidence from three regions using multiple and partial wavelet approaches

ABSTRACT

Credit risk linkage has primarily been examined from the lens of developed country markets and using volatility index. In this paper, we investigate the interconnectedness and causality among the global financial market risks during crisis periods, using partial and multiple wavelet coherence analysis. Specifically, we employ financial sector credit default swap indices from three regions (Asia, North America, and Europe) from January 2008 to June 2021 as a proxy for risk in the financial industry. The sample period includes three global crises, namely the 2008 global financial crisis, the European debt crisis, and the current coronavirus disease of 2019 pandemic. Our findings can be summarized as follows. First, credit risks in global financial markets are highly connected across the three regions. However, if the impact of a particular region is not considered, the other two regions become less connected in terms of credit risk. Second, considerable interactions among the credit risk of financial industries in the three regions occur during crisis periods. Third, significant relationships between credit risks in Asia and North America ensue in the long-term, which is independent of the European region. Our findings provide significant implications for financial market participants, as the credit risk transmission can directly affect not only financial market stability but also portfolio risk exposure.