Empirical Analysis of RMB Price Discovery Effects Between China Sovereign CDS spread, offshore RMB and Global Financial Market Variables: Comparative analysis of China, Japan and South Korea

Abstract

This study analyzed the lead-lag relationship between the country CDS premium in China and the spot exchange rate as well as the forward exchange rate of the offshore yuan currency, and global financial market variables. The results of the analysis were compared with those of the Japanese yen and Korean won, the latter of which is a non-international currency. The analysis was conducted from January 2013 to December 2017. The relationship between the national CDS premiums of China, Japan and Korea, as well as their spot exchange rates, the forward exchange rates, the interest rate of US Treasury bond which is a variable in the global financial market, credit risk spread, VIX index and TED spread, were analyzed through VECM model analysis, Granger causality analysis, impulse response analysis, and variance decomposition analysis. The results of the analysis are as follows: first, there was a long-term cointegration balance relation between the country CDS premiums of China, Japan and Korea and the analytic variables. Second, the Granger causality analysis revealed a significant feedback between the change rate of CDS, as well as that of the spot exchange rate and the forward exchange rate in China and Korea, and Korean won showed stronger intensity. However, no relation was found between the CDS premium in Japan and its spot exchange rate and forward exchange rate. Third, the error correction term of the VECM model between the CDS premiums and analytical variables of Korea and China was negative and significant, whereas the value of the Japanese error correction term was not significant. Fourth, the impulse response function analysis showed that the CDS premium in China continued to receive positive impacts from the global variables, but the adjustment process of the CDS in Korea was revealed to with its reverse from positive (+) to negative Fifth, the result of variance decomposition analysis showed that the VIX index had a strong explanatory power on the CDS of China, whereas in case of Korea, the explanatory power was strong on the CDS of the offshore forward exchange rate. Overall, the CDS in China was dominated by the global market variables rather than the yuan exchange rate; on the other hand, in the case of country CDS of Korea, the won-dollar exchange rate and the global market variables exchanged mutual impacts, and the intensity was also grater than that of the offshore yuan currency. However, the Japanese CDS had no causal relationship with the yen currency, because the foreign exchange market and the government bond market were fully liberalized. The implications of this study are as follows; In regards of the CDS premium of a country, not only the domestic but also the global financial market has risen in its importance; and while the impact of the global financial market on the yen and the won can be distributed to the CDS market and foreign exchange market, the impact on the offshore yuan currency can be focused on the CDS market. This has provided a significant information that although yuan is an SDR international currency to the participants in international financial markets, but it could still be sensitive to the impacts in changing financial market conditions, because its characteristics as a non-international currency still exist.