Abstract:

In this paper we decompose the variance of sovereign risk for 6 European countries, namely Germany, France, Italy, Romania, Hungary and the Czech Republic, using quarterly data from December 2008 onwards, into contributions of the world, country specific and idiosyncratic factors. In this regard, we compute a dynamic factor model with time-varying coefficients and stochastic volatility. The main results indicate that world factors have a dominant role in explaining sovereign risk, particularly during the period between December 2008 and December 2012, having a \U"-shaped distribution that reveals the phases of the European sovereign debt crisis. Moreover, we use two different proxies for sovereign risk { sovereign bonds and credit default swaps and we and that sovereign bonds give a more realistic and robust picture for the analyzed countries.