Abstract
This study examined the tail dependency structure of sovereign credit risk and three global risk factors in
BRICS countries using copulas approach, which is known for its ability to provide the “true” tail
correlation based on the correct marginal distribution. The empirical results show that global market risk
sentiment comoves with sovereign CDS spreads across BRICS countries under extreme market events,
with Brazil having the highest co-dependency followed by China, Russia, and South Africa. Therefore, it
is crucial for BRICS policymakers to consider financial sector regulations that mitigate spill-over risks
such as targeted capital controls when markets are distressed, to maintain financial system stability despite
unrestricted access to local financial markets by risk-averse foreign investors. Such policy can proactively
manage the impact of global sentiment on the country’s credit risk profile, which ultimately affects the
cost of borrowing and fiscal debt service costs.
Furthermore, oil price volatility is the second biggest risk factor correlated with sovereign CDS spreads
for Brazil and South Africa while exchange rate risk exhibits very small co-dependence with sovereign
CDS spreads under extreme market conditions dominated by tail events. On the contrary, exchange rate
risk is the second largest risk factor co-moving with China and Russia’s sovereign CDS spreads while oil
price volatility exhibits the lowest co-dependence to CDS in these countries. Between oil price and
currency risk, evidence of single risk factor dominance is found for Russia where exchange rate risk is
largely dominant (second to global sentiment), implying that Russia can mitigate or manage spillover
effects on sovereign CDS spreads by enacting targeted financial sector regulations that mitigate exchange
rate risk spillovers.
The optimal copula family for sovereign CDSs and exchange rate volatility is confirmed as Student-t
copula across all countries, suggesting symmetry and this is consistent with expectations documented in
existing literature. For the global risk sentiment, optimal copula is survival type (Joe-Clayton/Gumbel) to
Tawn type copulas which are asymmetrical and considers tail observations and this variable have the
strongest (and positive) association with sovereign CDS spreads of BRICS than any other global risk
factor under consideration in this study. This implies that global risk sentiment co-moves with sovereign
CDSs when extreme tail–end observations occur such that negative sentiment weakens CDSs while
extreme market optimism improves CDS spreads for BRICS countries.