The pass-through effects of oil price shocks on sovereign credit risks of GCC countries: Evidence from the TVP-SVAR-SV framework

We implement a two-stage methodology based on the structural vector autoregressive and time-varying parameter vector autoregressive models to examine the time-varying effect of distinct types of oil-price shocks on sovereign credit risks measured by credit default swap (CDS) spreads in Gulf Cooperation Council countries. Using monthly data for the period from May 2011 to February 2022, our results show time-varying responses to structural oil shocks in the short- and medium-run periods, with more fluctuations in responses detected over the full sample period in the former. Overall, we detect a break in the contagious impacts of oil shocks during and in the aftermath of, the 2014–2015 oil crisis and COVID-19 crisis. Specifically, the Bahraini market is found to exhibit a positive (negative) reaction to the oil supply shocks (OS) and oil market-specific demand shocks (OSD) throughout the pandemic period. Furthermore, we uncover a transient response from the Saudi and Qatari CDS spreads to the aggregate demand shocks (ADS) and the OSD over the full sample period, indicating the need for portfolio rebalancing. In the UAE, we detect a positive impact over the three sampled years of OSD since 2011. Moreover, a notable decoupling pattern continues to appear between short- and medium-term innovations in the ADS. Our results suggest adopting more conservative trading in the CDS markets while understanding the oil price and the economic state. The complexity of the trading strategy should also depend on the target Gulf market itself and that seems essential when it comes to investing in Qatar and Saudi Arabia.