Finansial interconnectedness between European countries
Specialeforsvar ved Sandie Wrona
Titel: Financial interconnectedness between European countries
Abstract: This master thesis provides an analysis of the financial interconnection between 11 original euro area members and Denmark. It features an application of Regular Vine copulas, which provides a graphical and flexible tool for modeling complex dependence structures using a variety of bivariate copulae. The thesis investigates how financial stress interacts for 66 country-pairs, but it also determines the dependence structure of all countries as a whole. Furthermore, the risk of contagion of financial distress is analyzed by exploring the tail dependence between financial stress indices.
The thesis utilizes an ARMA-GARCH R-vine copula approach to analyze comovements in financial stress indices constructed by Duprey et al. (2015). The data is provided by the Statistical Data Warehouse of the European Central Bank, and the sample covers the period from January 2001 to May 2019. The R-vine copula results show that larger and core economies of the euro area are more closely interrelated. Denmark, Finland, and The Netherlands constitute a sub-group of linked countries, so does Ireland, Portugal, and Greece. France directly links to five countries, which makes France the most interconnected node. Belgium is the second most connected country; linked to three nodes. 57 country-pairs have closer upper tail dependence, but 44 country-pairs have non-zero lower tail dependence aswell. The presence of lower tail dependence, that is co-movements in extreme negative events implies the existence of a channel through which financial distress might spread. France exhibits closest lower tail dependence, which combined with the highest interconnectedness with other countries, enlarges the risk of contagion of distress.
The knowledge of different dependence structures among countries, and knowing that some countries are more strongly tied in times of financial turmoil, may be useful in order to target macroprudential regulation and efficiently achieving quicker financial stability.
Vejleder: Rolf Poulsen
Censor: Cathrine Jessen, ATP