Pricing of Sovereign Credit Risk: Evidence from Advanced Economies during the Financial Crisis (original) (raw)
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We investigate the pricing of sovereign credit risk over the period 2008-2010 for selected advanced economies by examining two widely-used indicators: sovereign credit default swap (CDS) and relative asset swap (RAS) spreads. Cointegration analysis suggests the existence of an imperfect market arbitrage relationship between the cash (RAS) and the derivatives (CDS) markets, with price discovery taking place in the latter. Likewise, panel regressions aimed at uncovering the fundamental drivers of the two indicators show that the CDS market, although less liquid, has provided a better signal for sovereign credit risk during the period of the recent financial crisis.
Credit Default Swaps and Sovereign Debt Markets
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This article presents an analysis of the possible relationship existing between the spreads of sovereign bonds and the premia of credit default swaps (CDS), in order to determine if they are useful tools for measuring the sovereign risk either separately or taking into account the joint evolution of their values. Data on several countries representative of various regions of the world, developed and emerging economies, have been used. The empirical methodology used in the paper is related to the stationarity of the series, the degree of cointegration and tests of causality. In general, a relationship of cointegration between the two measures is found for some of the countries analyzed. When we study the causality, according to Granger, for these variables, the CDS premium is found to be the cause of the risk spreads in the majority of cases. In the light of the data and their corresponding interpretation, we can conclude that dealings in the CDS market contain clear and fairly usefu...
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Recent studies suggested that financial markets correlations and volatilities change during crisis periods. This paper presents a practical framework to test the volatility of sovereign credit default market and sovereign bond market indexes during the sovereign crisis period. Furthermore, our research tests the dynamic relationship between the sovereign CDS market evolution and the sovereign bond market, based on a sample of 10 developed Eurozone countries. Then, we integrate the bond debt's sensitivity presented by its maturity, which is a line of research supported by previous studies. Our results show that both markets are sensitive to internal shocks. Moreover, the dynamic relationship between the two markets is more sensitive to negative information than positive information. Finally, maturity significantly affects the sensitivity of sovereign bonds to CDS market evolution. This study contributes to the empirical literature by presenting, to the best of our knowledge, an unprecedented empirical investigation of the sovereign bond maturity effect's sensitivity to the sovereign CDS market evolution.
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International Journal of Financial Engineering, 2015
In this paper, we investigate the nature of sovereign credit risk for selected Asian and European countries based on a set of sovereign CDS data over an eight-year period that includes the episode of the 2007–2008 global financial crisis. Our results indicate that there exists strong commonality in sovereign credit risk among the countries studied in this paper following the crisis. In addition, our results also show that commonality is importantly associated with both local and global financial and economic variables. However, there are markedly different impacts of the sovereign of credit risk in Asian and European countries. Specifically, we find that foreign reserve, global stock market, and volatility risk premium, affect Asian and European sovereign credit risks in the opposite direction. Lastly, we model the arrival rates of credit events as a square-root diffusion process from which a pricing model is constructed and estimated over pre- and post-crisis periods. Then the resu...
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Journal of Banking & Finance, 2013
In this study, we use a factor model in order to decompose CDS spreads into default, liquidity, systematic liquidity and correlation components. By calibrating the model to sovereign CDSs and bonds we are able to present better decomposition and more accurate measure of spread components. Our analysis reveals that sovereign CDS spreads are highly impacted by liquidity risk (i.e 50% of default risk and 49.91% of liquidity risk) and that sovereign bond spreads are less subject to liquidity frictions and therefore represent a better poxy for sovereign default risk (i.e 97.08% of default risk and 1.73% of liquidity risk). Furthermore, our model extension enables us to directly study the effect of systematic liquidity and flight-to-liquidity risks on bond and CDS spreads through the factor sensitivity matrix. Although these risks do have an influence on the default intensity, the magnitude of their impact is small and therefore they do not contribute significantly to spread movements.