Abstract We investigate how a correct decomposition of the credit default swap (CDS) quote into redenomination and default risks allows us to explore effectively the dynamic interconnections between such noteworthy events in four countries in the Euro area. We employ daily CDS data denominated in different currencies and default clauses from November 2015 to September 2023. We make original use of the TVP-VAR frequency connectedness approach, which can provide us with more accurate information about the direction and scale of propagation of foreign redenomination risk shocks on default premia during recent crisis periods and within short- and long-run frequencies. Our main result is that connectedness is significant although, quantitatively, time-dependent and intensified during extreme events, revealing the vital role of systemic risk factors that drive the euro area sovereign bond markets. Overall, we show that the net connectedness is from denomination risk to default risk for most of the cases of the entire sample. Furthermore, we observe that redenomination shocks in a particular country led to a rise in the default risk of other countries within the Euro area. Splitting the connectedness indices into high- and low-frequency components indicates that default risk is often identified as the net transmitter of redenomination risk for connectedness in the short term. Furthermore, the long-term pattern of propagation highlights that most of the transmitted shocks originated from redenomination risk. Policymakers and investors should employ adaptable regulatory and investment strategies because of the interchangeable nature of redenomination and default risks, especially changes in frequency spillovers.
Chebbi et al. (Sun,) studied this question.