Calling credit contagion the dependence of likelihood of big losses across industries which cannot be explained by correlation, we find an `indirect' evidence on credit contagion in the CDS market. To investigate the market expectation about both intra- and cross-industry credit contagion priced in CDS spreads from 2006 to 2010, we construct industry-wide credit portfolios using an extensive cross-sectional corporate CDS data and model portfolio losses by bivariate Hawkes processes which recently draw researchers’ attention to explain clustered big movements of securities’ returns.
Our empirical results show that systemic credit risk of finance sector sharply increases during the financial crisis and it is substantially contagious to non-financial sectors. The contagion measure indicates that most of the highly increased CDS spreads in non-financial sectors are due to the contagious systemic credit risk, which confirms that market participants in non-financial sector request high premiums to compensate contagion risk from financial sector.
In addition, our estimation provides that while investors optimistically anticipate that the big event which causes 38% of the financial institutions to default would occur once in 1753 years in 2006, their view is radically altered into once in 194 years, 4.72 years and 1.49 years in 2007, 2008 and 2009, respectively as the crisis progresses