Cross correlations in European government bonds and EuroStoxx

TL;DR

This paper analyzes the systemic risk in European markets by applying PCA to cross correlations of government bonds and stocks, introducing CARS to visualize risk evolution and revealing increased coupling during the sovereign debt crisis.

Contribution

It introduces the conditional average rolling sum (CARS) as a new visualization tool for systemic risk and demonstrates the increased coupling of bonds and stocks during the crisis.

Findings

Risk of bonds and stocks moved independently before 2010.

Coupling between bonds and stocks increased during the debt crisis.

Amplitude of risk oscillations grew, indicating higher vulnerability.

Abstract

We use principle component analysis (PCA) of cross correlations in European government bonds and European stocks to investigate the systemic risk contained in the European economy. We tackle the task to visualize the evolution of risk, introducing the conditional average rolling sum (CARS). Using this tool we see that the risk of government bonds and stocks had an independent movement. But in the course of the European sovereign debt crisis the coupling between bonds and stocks has strongly ncreased. This results in an in-phase oscillation of risk for both markets since mid 2010. In our data, we observe a steep amplitude increase, suggesting a high vulnerability of the two coupled systems.