Contagion of credit risk: Comparative analysis before and after the pandemic of COVID‐19

• Published date: 01 October 2022
• Author: Takayasu Ito
• Date: 01 October 2022
• DOI: http://doi.org/10.1002/jcaf.22562

Received: 5 April 2022 Accepted: 27 April 2022

DOI: 10.1002/jcaf.22562

RESEARCH ARTICLE

Contagion of credit risk: Comparative analysis before and

after the pandemic of COVID-19

Takayasu Ito

School of Commerce, Meiji University,

Chiyoda-ku, Tokyo,Japan

Correspondence

TakayasuIto, School of Commerce, Meiji

University, Chiyoda-ku, Tokyo, Japan

Email: tito747@meiji.ac.jp

Funding information

This paper is a result of individual

research project provided by the Institute

of Social Sciences, Meiji University.

Abstract

The spreads of credit default swaps (CDS) in Germany, Japan, United King-

dom, and United States move together before the COVID-19 pandemic with few

mutual causalities. However, they do not move together after the pandemic and

have more mutual causalities. The credit risk of four major countries—Germany,

Japan, United Kingdom, and United States are connected due to their relative

stability before the pandemic. However, they are not connected in terms of the

differences in public spending between the countries during COVID-19. This

makes the CDS market more sensitive to credit risk in each nation, resulting in

the independent move of credit risk among the four countries.

KEYWORDS

cointegration, contagion of credit risk, covid-19, credit default swap

JEL CLASSIFICATION

C32, E44, G15

1 INTRODUCTION

The outbreak of the COVID-19 pandemic began in China

at the end of January 2020 and was identified in northern

Italy at the end of February 2020, from where it quickly

spread to the rest of Europe and to Asian and American

countries. As the pandemic intensified, world financial

markets tumbled. For example, stock prices declined and

the yields of sovereign bonds climbed. The spreads of credit

default swaps (CDS) increased sharply because finan-

cial market practitioners were concerned that sovereign

credit risk would deteriorate1. Many countries decided to

issue more sovereign bonds to support stagnant economies

caused by the COVID-19 pandemic.

Tokic (2020) concludes that “the COVID-19 pandemic

is likely to accelerate the trends of de-globalization and

de-dollarization and to create an opportunity for building

more sustainable globalization.” It is expected that there

will be structural change in the financial market following

the COVID-19 pandemic. This paper focuses on the conta-

gion of credit risk among four major countries—Germany,

Japan, United Kingdom, and United States, by analyzing

the market of CDS. The study divides the sample period

into two at the beginning of worldwide pandemic to make

a comparative analysis.

CDS refers to a financial swap agreement whereby the

seller compensates the buyer if there is a credit event. As

mentioned in Ito (2020), “the buyer of the CDS makes a

series of payments to the seller and, in exchange, receives

a compensation payoff if there is a default, whereupon

the seller retakes possession of the defaulting bond or

loan.” When the credit risk increases in a country,the CDS

premium increases. As Ito (2020) states, “it is therefore

appropriate to use the CDS spreads to measure credit risk

in the financial system.”

To date there have been not so many literatures written

on the impact of the COVID-19 pandemic on the CDS mar-

ket because the first outbreak of coronaviruspandemic was

confirmed in China at the end of January 2020. There is no

literature analyzing the CDS market of Germany, Japan,

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