Abstract
This paper studies international sovereign Credit Default Swaps (CDS) market focusing attention to the CDS of Central and East Europe. The main purpose of the study was to perform detail analysis of Lithuanian CDS in the global capital market. We compared the CDS markets of other countries and found some commonalities between them. We study the credit curve produced by CDS and volatility of CDS. A great attention is paid to investigate the relationship of CDS and the government bond market. Analysis of finding a leading role of CDS and the bond markets in the price discovering process is made. A leading market for different periods is found by using the Vector Error Correction model. Our main finding is that during the volatile period price discovery takes place in the bond market and in the calm period price discovery is observed in the CDS market. Disclosed relationship between CDS spreads and Eurobonds yield risk premium gives an additional decision making tool for sovereign debt managers.
Highlights
Since bankruptcy of Lehman Brothers, the government debt market has attracted particular attention
It is worth to notice that Coudert and Gex (2010) made a conclusion that the Credit Default Swaps (CDS) spread in emerging markets including Lithuania took a leading position with respect to bonds in 2007–2010
We found that the liquidity characterized by the turnover of US$55m per week is low compared to the average liquidity of the credit derivatives, yet it is high in Lithuanian standards
Summary
Since bankruptcy of Lehman Brothers, the government debt market has attracted particular attention. Before this event, the credit market had been focused on corporate credit risk. Credit risk of the EU countries was revised by the market on the largest scale. Liquidity shortage in a huge banking system of Iceland created problems to repay the country’s debt. In this paper we provide a brief overview of the Lithuanian CDS market and CDS of other Baltic countries. We grant the greatest attention to relationship between the bond and the CDS markets in Lithuania. Does CDS react first and the bond price adjusts to the CDS, or vice versa? We apply the Vector Error Correction Model (VECM) to find the leading market
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